It is essential to understand that both the Profits of your business and its cash flows are equally important. Only when they are properly managed can the company be successful.
For a business to be successful, it is vital to monitor both closely. If you are starting your business, you must understand these two concepts.
What is cash flow?
This term refers to all the money that “flows” to and from your business. That is all the money that customers spend when consuming your product or service. And it also includes all the money your company pays to function (rent, materials, payroll, advertising, etc.).
Cash flow over a period can be positive or negative. If it is negative, you are using more money than you are receiving over that particular period. To have a positive flow, you must be receiving more money than you spend on day-to-day operations. It is a simple concept. However, it is not so easy to achieve, especially at the beginning.
What are Profits?
Profits are the net income of a business. They are generally calculated as follows: All revenue (sales) minus operating costs and taxes.
Difference between cash flow and Profits.
Having cash at the bank and making a profit is not the same thing, although, to some extent, the two are related. Even a profitable business experiennce cash flow problems, whilst companies that are not profitable may temporarily have surplus cash in the bank.
Managing for profit
Profitability comes from two key elements
- Ensuring that your business is earning the correct gross profit on the sale of its products or services after deducting its direct costs
- Controlling levels of overheads expenses
Managing the cash
Good cash flow is achieved by managing cash resources effectively. It involves
- Ensuring the business is running profitably – See above.
- Effective control of debtors – ensuring that you receive payments on time.
- Taking available credit on purchases.
- Correct management and financing of capital projects.
- Getting proper stocking levels to avoid locking up too much capital in stock.
Small businesses with limited funding shouldn’t just focus on profits; they should focus on cash flow. That is the real monetary resources used to support operations. Why?
Lack of cash flow is one of the main reasons many small businesses fail in the first few years. If you run out of money, you cannot continue operating your business. Simple as that. Thus, when you are starting your business, the most important thing is to do everything possible so that your customers buy your product or service. It is not so important to project how much you could earn in five years, but you should focus on surviving for two years.
A steady cash flow will allow you to invest more in your business and improve your long-term profits.
The cash requirements of a business are very often under-estimated by its managers, but time spent assessing the cash needs of the company will be time well spent
It will:
- Identify times when cash will be in short supply so that you can plan accordingly.
- Ensure adequate funds are available for capital projects.
- Allow decisions to be made on a sound basis leading to greater efficiency and increased profits.
Good cash flow management helps you keep track of how efficient the business is running.
To find out how we can assist you efficiently manage your cash flow through automation, contact us for a free no-commitment consultation.
