Why you need to care more about cash flow than profits
06/08/2018 / Comments 0
You may have heard the saying “turnover is vanity, profit is sanity but cash is reality”. But why is cash flow more important?
When it comes to your business’s finances, determining success can be challenging.
It’s all too easy to oversimplify financial success or failure into profit or loss. But the reality is far more complex than that.
For a business to be successful in the long term it needs to generate profits, of course. However, focusing purely on profit and ignoring cash flow can be a risky strategy and potentially prevent your business from reaching its true potential.
Here, we consider 5 reasons why cash flow is more important to your business than profit.
1. Cash flow provides a clearer view of the condition of your business
When looking at company accounts many people focus on profit, as this shows what is left after all expenses have been deducted from revenue. But profit numbers aren’t always straightforward.
Profits can be skewed by a number of factors such as the number of days in the reporting period or seasonal imbalances. Plus, if a business makes a sale on credit terms it may not receive all of that money until months later (or even not at all), but it could recognise the entire value of the sale immediately in its books.
On the other hand, cash flow shows exactly what is going in and out of the business at all times. This can provide a more transparent look at the financial health of a business.
2. Cash flow is necessary to pay employees and bills
Profit doesn’t necessarily mean you have cash available. It is possible for a business to show a profit every month but still not have enough working capital to pay their bills.
If too much money is tied up in assets or accounts receivables it can be challenging for a business to meet their monthly commitments, such as paying employees, rent and utilities.
Without working capital available businesses can fall behind on essential payments and find themselves in trouble.
3. Cash flow sets you up for long-term success
Cash flow, not profit, determines viability. In fact, one of the leading causes of business failure is poor cash flow management.
Profit is obviously essential for a business to be able to prosper in the long term, but especially in the early stages of business cash flow is more important.
Failure to monitor your cash flow effectively could mean that your business isn’t even around long enough to show a profit.
4. Cash flow allows for sustainable growth
Whilst business growth sounds positive, if you try to grow a company without the right resources in place it can actually do more harm than good.
Having a positive cash flow allows a business to reinvest in itself and capitalise on new opportunities without putting itself in financial difficulty.
Overtrading, for example, is one of the biggest mistakes companies can make. Committing to more orders than your cash flow allows can cause complications when you trade on credit terms, as you’ll need to pay suppliers and provide the goods or services in advance of getting paid.
Buy by being sensible about how much new business you take on, you can ensure your company grows sustainably.
5. Cash flow protects against future challenges
Having a positive cash flow can provide a buffer against future financial challenges.
You can never predict when something is going to go wrong.
Whether it’s due to an unexpected expense, a customer missing a payment deadline or a company going bust, having some kind of contingency fund available is always advisable.
If you focus solely on profits you may not have the necessary funds to bridge a cash flow gap if it occurs.
…but don’t neglect profits entirely
Whilst we stand by the fact that cash flow is one of the most important elements of financial success you shouldn’t ignore profits completely.
The absence of profit eventually has a declining impact on cash flow, so effectively monitoring them both together will give your business the best possible chance of success.
Do you need help maintaining a healthy cash flow? As the UK’s trusted commercial finance broker we could help you find the most suitable solution for your cash flow needs. Contact us on 0800 9774833 to discuss your requirements.