Many small business-owners experience this feeling when they look at their books. You work hard, money comes in but it all just seems to disappear. Why?
Profit versus Cash Flow
Firstly, let’s get some basics out of the way and look at what profit and cash flow actually are. It seems too many small business owners find these two confusing.
In its simplest form, profit is what is left over after subtracting your expenses from your revenue (sales). A simple Profit & Loss report in an accounting package clearly gives this information. However, comparing sales and expenses every now and again on a piece of paper can be far more confusing. Profit is usually the first number a business owner will look at to determine if all the effort they put in is worth it. It is also the number, with some adjustments, that you pay tax on.
On the other hand, cash flow refers to the balance of cash moving in and out of a business. If more cash comes in, then you have a positive cash flow and vice versa. While maybe not as eye catching as a good net profit, cash flow is just as important, if not more so. The time it takes for your clients to pay is critical to cash flow.
There may only be a subtle difference when looking at profit compared to cash flow and they can often reflect each other, but this isn’t necessarily the case and high profits don’t always produce positive cashflows. One isn’t more important than the other, but managing both well is essential to running a successful business.
Why the difference?
There are some key differences between profit and cash flow that usually explains why they aren’t the same. Here are some examples of where these two differ:
Having your business’ funds at your fingertips can make it too easy to withdraw money out at any time to meet your personal needs. While this may sound self-explanatory, many small businesses fall into this trap. To help avoid this trap:
Taxes and Super
Knowing when your tax and employee obligations are due to be paid will allow more effective planning and budgeting for your business. With the different timings of when all these payments are due, it can be easy to lose track. To assist in managing your tax and super obligations:
Slow customers payments will negatively affect your business’ cashflow. Fortunately, there are ways that this can be avoided:
New Business and Expansion
If you are just starting a business or looking to expand, it is inevitable that you will be experiencing higher cash outgoings. This can be good in the long run but understanding and managing your cash flow during this period is extremely important.
The differences between profit and cashflow can easily be misleading when managing the operations of your business. In brief, best practise is to plan in advance for the upcoming costs and monitoring cash flow regularly.
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