Is it possible to show profit on paper but still not have enough to run your small business?
The answer is yes. The promise of profits on paper is no guarantee that your business is holding a sufficient amount of cash for day-to-day operations. On the other hand, receiving steady amounts of cash throughout your business’s lifetime won’t always mean you’re earning a profit.
It’s essential that you understand the difference between cash flow and profit and what it means for your business.
Here’s how you can differentiate the two:
1. The numbers are time-sensitive.
Cash flow refers to the actual transfer of funds in and out of your business. It lets you monitor how much cash you have on hand by acknowledging expenses and income only when money is paid or received.
On the other hand, profits can be recorded once a sale has been made. Even prior to receipt or delivery of payment, your books already include information regarding how much the business has earned.
2. To profit means to earn in excess.
Profit is what’s left of your revenue after deducting the full costs of making, marketing, and delivering your product.
If it takes you $60 to prepare and deliver a box of pastries, and you sell it for the same price, you won’t be earning any profits. However, your cash flow is going to reflect how much you shelled out for the product and how much you received for it as payment.
3. Cash flow is similar to gatekeeping.
A good way to illustrate cash flow is to imagine people at a train station. The gate only records the number of people who have gone through even if there are others waiting on either side.
Counting in this scenario is sensitive to two directions of flow: in and out. Many accountants make the same distinction when talking about cash by using the words inflow and outflow.
4. Inflows and outflows aren’t always ‘good’ or ‘bad’.
Having a steady inflow of cash only means that you have money regularly coming into the business. This won’t always give you the ability to cover all expenses or to earn a little extra.
As long as you’re putting money into income-generating processes, you probably won’t be dealing with losses when you have multiple cash outflows. Most businesses experience cash outflows during the early portion of their business cycle, right before sales are made and cash flows back in.
5. Cash will always run the business.
Focusing finances on the right things is a huge responsibility for all business owners. Without cash, your business won’t survive as it’s can’t cover the cost of running itself.
This is why prioritising cash flow can make more sense than a profit-oriented approach. Financial security is the daily goal your business needs to aim for before it can reach the point of earning more profits.
Want to learn more about business and cash flow management? Our friendly team of professional business advisers and accountants are more than willing to help. Contact Omnis Group at 9380-3555 or 1800 99 66 90.