Why cash flow is more important than profit
Mon Nov 11 2019
“You don’t know what your net profit was in year 1?” Cue huffing and puffing, and incredulous looks.
We’ve all seen entrepreneurs spectacularly fail to get investment when they don’t know their numbers. But what if you do know your figures but you can’t fathom why you’re strapped for cash when your profits are so healthy. None of these scenarios need apply to you; sometimes simply understanding the difference between cash flow and profit (see below), then looking at profit versus cash flow can help you run a tight ship.
Business cash flow is: the total amount of money going into and coming out of a business.
Profit is the difference between the amount earned and the amount spent in buying, operating, or producing something.
Here are seven reasons why cash flow could be more important than profit, and a link at the end with handy tips on improving cash flow.
1. Cash flow can be bought, profit can't
If cash flow is a problem, a small business owner could secure a loan against the assets that their money is tied up in. You can’t secure a loan based on profit. Boosting your cash flow in this way can be a lifeline for small businesses looking to bridge the gap between ‘ticking along’ and ‘’high growth’. Getting yourself a business credit card and using it responsibly can also be a way to boost cash flow, while also helping you build an all-important business credit rating.
2. Investors and analysts will look at operating cash flow to determine a business’s potential
If you’re looking for financial investment, it’s important to understand that analysts and potential investors will look at the business figures in full. This means revenue, net income and operating cash flow will together paint a picture of how well (or badly) a business can support itself and therefore its potential to grow. A business that's in profit can still go under if cash flow is poor (see below).
Operating cash flow is cash generated from operations (i.e. selling gifts in a shop), minus any tax and interest paid, investment income received and less dividends paid.
3. Positive cash flow will allow you to be proactive in the way you do business
Having cash in the bank is great for small businesses for all the reasons mentioned above. And it also opens up a world of opportunity for investment in research and development, employee training, outside expertise - for example in cyber security or payment technology and upgraded technology, such as accepting card payments, turning your online presence from a brochure website to an eCommerce site. Profit could also give you such opportunities as long as it’s not tied up in assets.
4. Cash flow is an incredibly difficult metric to manipulate
One of the reasons why investors and analysts will look at cash flow closely before investing in a business is because it’s very difficult to manipulate. This means it’s often seen as a reliable way of determining the health of your business. Profit, on the other hand, can be calculated and interpreted in a number of different ways to paint a particular picture.
5. Good cash flow management can mean a healthy business future
Profit is notoriously difficult to predict, and the profit you do make can be tied up in assets. But cash flow is something a business can project. This means you, as a small business owner, can plan for future income and expenses, and in doing so highlight any potential problems that may arise in the future, giving you more time to avoid them.
6. Bad cash flow could affect business credit ratings and reputation
Picture this: you apply for a business loan and are approved but your interest rate is quite high because you’re perceived to be a high risk investment. If repayments become difficult, there’s a chance your business credit rating could dip. Businesses enjoying good cash flow could well avoid the need for loans altogether, so if there’s ever an incentive for reading an article on seven ways to improve cash flow, this is it.
7. Good cash flow means your business can avoid taking on debt
You need money to pay staff, pay suppliers, buy stock, invest in the grand future of your business and much more. If you have good cash flow, you’re less likely to need to take on debt in the form of loans. And a business with no debt is an enviable thing to have.