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Cash is king: Why cash flow matters more than profits

Improving cash flow is a smart move for any business.

It doesn’t matter how great your business model is, how profitable you are, or how many investors you have lined up. You won’t survive if you can’t manage your company’s cash.

In fact, one study found that 82% of businesses fail due to poor cash flow management skills. If you’re looking for one area to focus on that will have a dramatic impact on your business, this is it.

Established businesses often have a buffer of extra cash to get them through shortfalls. Growing businesses often don’t because they are always reinvesting.

Years with the biggest growth—including the first few years—are also the most challenging when it comes to cash flow. This is one of the reasons it’s so hard to get a new business off the ground.

Getting good at managing cash flow is one of the best things you can do for your business. Not only that, it’s a skill you can carry over into other businesses, as well as your personal finances.

The Difference Between Cash Flow and Profitability

Cash flow is not the same as profitability. A profitable business can still be unable to pay its bills. Similarly, just because a business is meeting all of its financial obligations, doesn’t mean it’s profitable.

Profit is an accounting term, which really only exists on paper. Measuring profit is a very specific way of looking at a business. It doesn’t tell you a whole lot about how the business is getting by day-to-day.

Calculating Profit

Profit is typically calculated in two steps. The first is to take your total revenue and subtract the cost of the goods sold. The difference is your gross profit.

Revenue – Cost of Goods Sold = Gross Profit

For example, if you sold R100,000 in rocking chairs, and the chairs themselves cost you R50,000 wholesale, your gross profit would be R50,000.

Revenue: R100 000
Cost of Goods Sold: -R50 000
Gross Profit: R50 000

Of course, you would probably have other expenses beyond buying the chairs. For example, you’d need a place to store the chairs, and you might want to run some ads to get more sales. These expenses are called operating expenses and they get subtracted from your gross profit.

Operating expenses include most costs that are not directly connected to what you’re selling. Things like rent, equipment, payroll, and marketing.

The second step to calculating profit it to subtract operating expenses from gross profit. The difference is net profit.

Revenue: R100 000
Cost of Goods Sold: -R50 000
Gross Profit: R50 000
Operating Expenses: R35 000
Net Profit: R15 000

If your net profit is a positive number, you made money. If it’s a negative number, you lost money.

Real world example: Blue Label

Reviewed condensed Group statement of comprehensive income For the year ended 31 May

The Problem With Profit

The problem with income statements is that they don’t show your whole business. A few very important pieces of information are missing.

1. Debt Repayment
If you have any business loans or other startup capital to repay, it won’t show up here. Only the interest on those loans will be included on a P&L. Even though debt repayments can eat up a lot of cash.

2. Equipment Payments
Similarly, if you make a major equipment purchase, the entire cost will not show up here. Instead, that cost will get spread out over the lifetime of the equipment. If you spend R100,000 on a canning line and you think it will last you ten years, your income statement will show an expense of R10,000/year for ten years. Even if you had to pay all of it upfront.

3. Taxes
It’s also important to note that your net profit hasn’t been taxed yet. This means it’s going to shrink even more. Even if all of your profit is available in cash, you won’t be able to run out and spend it all in one place.

4. Cash Received
Finally, many businesses use accrual accounting, which records revenue even if you haven’t received the money yet. On paper, you might have R200,000 in sales but if no one has paid you yet, you’re still going to have a hard time paying your bills.

Further, if you carry inventory, all that product has value and gets included on your income statement as well. Of course, in order to extract cash from your inventory, you need to sell it first.

It’s All About Timing

Ultimately, cash flow comes down to timing. You may be profitable over the course of a month or year, but not a specific day or week. If your bills are due at the beginning of the month but you won’t have any money in the bank until the end of the month, you’ve got a cash flow problem. Even if at the end of the month, you made more than you spent.

Here’s the deal with profit. If you’re not profitable on paper, you’re in bad shape. You need to either increase your revenue or decrease your expenses if you want to stay in business.

But just because you’re profitable, doesn’t mean your business can run on autopilot. You still need to watch your cash—especially if you’re growing.

Newswire

Newswire

The Platinum Wealth Newswire publishes content from opinion pieces submitted by various financial writers, journalists and analysts. Got a story? Send us an email to: news [at] platinumwealth.co.za