As a small business owner, you have probably heard the terms “profit” and “cash flow used synonymously. Mixing these financial indicators, though, could have disastrous results for your company.
The differences between the two could greatly affect the financial situation of your company and your decision-making process.
To help you avoid mistaking cash flow and profit, below is a brief overview of each with the help of accounting for LLC.
What are profits?
Profits are the excess left over after deducting all of your expenses from your income.
If you have developed a strong company plan and sought advice from a qualified accountant, your bookkeeping records should show profits.
On paper, though, profits may not necessarily transfer into accessible cash in your bank account.
What is cash flow?
The net total of cash entering and leaving your company is known as cash flow.
Positive cash flow indicates that, from sales and other sources, you have more cash than you are expending on running expenses, salaries, etc.
Negative cash flow, then, is the reverse—more money leaving the company than entering it.
Cash flow, unlike profits, shows the liquidity of your company right now.
Why they are both important
Understanding profit and cash flow can significantly benefit your small business:
- Strategic planning: Knowing your profit can help you with long-term strategy planning and evaluation of the feasibility of fresh ideas. It indicates whether your company can develop and keep itself going throughout time.
- Day-to-day operations: Positive cash flow guarantees that, without using credit or outside financing, you can meet your urgent needs including payroll and inventory purchases.
- Investor and lender attractiveness: Stakeholders depend critically on both measures. Although earnings usually appeal to investors, lenders mostly consider cash flow to determine your loan repayment capability.
Profit vs cash flow
More important than profit is cash flow. Imagine intending to add employees and purchase a new office, only to discover your bank account devoid of the funds needed to pay for these expenses, even if your company is lucrative.
On paper, profit seems great, but without enough cash flow, you cannot pay bills, rent, or labor. Monitoring cash flow is therefore absolutely vital for:
- Liquidity: More money lets you cover bills and guard your credit score.
- Growth: Positive cash flow enables you to make equipment and inventory investments.
- Demand: Higher demand will help you to manage rising expenses.
- Financial decisions: Strong cash flow enables you to negotiate uncertainty and make wise decisions in regard to finances.
- Investment: It helps you draw in money and guarantee loans.
Good cash flow essentially promotes expansion beyond only profit-making and maintains your company working as it should.
Monitoring cash flow and profit
Monitoring the profitability and cash flow of your company will allow you to manage your money and make wise corporate decisions. Forecasts of cash flow let you prepare for potential future shortages.
Conversely, profitability tracking helps you to watch income growth, figure out your return on investment, and find areas of the company might be underperforming. Together, tracking cash flow and profitability will enable you to prioritize your spending choices and spot areas of the company that might call for attention.
Conclusion
The bottom line is that any business owner must first grasp the distinction between cash flow and profit. Although both metrics are linked, they are separate financial indicators assessing different facets of the operations of a company. Although profitability lets the owner of the company grow and expand, solid cash flow makes sure the company survives and thrives. Monitoring cash flow and profitability enables the owner of the company to make wise financial decisions to maintain its profitability and general state of affairs.
