Graphic comparing cash flow and profit

Is Cash Flow More Important Than Profit?

A very common mistake for small business owners is to focus solely on profits, neglecting the importance of cash flow. Cash flow is vital for keeping the financial side of a business healthy. Without it, you are limited in what you can do to keep your business operating successfully.

So, what is cash flow exactly? Why is it so crucial for a business? Here’s everything you need to know.

What is the Definition of Cash Flow?

Cash flow is the money that flows in and out of a business. It is what a business utilizes for the daily running costs, such as purchasing inventory, paying staff, taxes, rent, and utilities. Having a positive cash flow shows that a company is “liquid”, because you’re earning more than you’re spending. Therefore, it can increase its assets.

A positive cash flow also shows that a business can pay out to shareholders, pay expenses and debts, and also have cash in reserve to cover unforeseen events.

If a business’s cash flow is negative, then it shows the opposite of the above. Decreasing liquidity means the inability to pay for obligated expenses, bills, and invoices.

How is Cash Flow Calculated?

There are three different ways that cash flow is calculated:

Which Factors Affect Cash Flow?

Cash flow isn’t always straightforward. A range of factors can affect the amount of available cash flow:

What are the Benefits of Positive Cash Flow?

Having a positive cash flow statement allows you to meet the financial obligations of the business without going into the red or having to borrow money. It also gives you the buffer zone required should anything unexpected happen. For example, if a piece of vital machinery breaks, having the cash flow to pay for the repair will mean you’re back in business asap.

A positive cash flow report also improves your credit rating. This is good news if you require outside investment or credit at some point. Positive cash flow also improves your ability to expand and scale your business.

What is the Definition of Profit?

Profit is one of the key factors that determine a business’s success. It is defined as the amount that remains after all outgoing expenses have been fulfilled. For example, if your business generates $20,000 in sales but it costs $15,000 to generate that $20,000, it means your profit is only $5,000.

Profit gives the overall picture of your business and is the amount used on which to base your taxes.

How is Profit Calculated?

Gross and net are the two different types of profit that can be calculated:

Why Profit Isn't Always the Most Important Metric

While profit is crucial to creating cash flow within your business, it doesn’t determine the amount of cash flow available. Profits are susceptible to manipulation because businesses can use non-cash expenses such as charitable write-offs, depreciation, and amortization to offset large capital expenses. Your business may see a profit each and every month, but if it’s tied up in accounts receivable or hard assets, you won’t have the cash flow to settle your cash outflow. Essentially, profit doesn’t keep the business running, cash flow does!

The Drawbacks to Maximizing Profits at all Costs

While, on the surface, it makes sense to prioritize maximizing your profits, this isn’t always advantageous. This is due to a number of reasons:

What is the Importance of Cash Flow Over Profit?

Without cash flow, you cannot pay your bills, invest in your company, or pay for anything you need. You need to generate profit to stimulate cash flow, but if that profit is tied up, you won’t have the liquidity required to operate efficiently. The advantage that cash flow has over profit is timing. Cash flow reports show you the status of your finances in real time, while profit is unable tell you when those cash inflows and outflows are coming.

How Does Cash Flow Help Business Growth?

If the cash flow statement is positive, you have many options available to aid business growth. Firstly, you have the cash to invest in much-needed staff or equipment. Secondly, your healthy credit score and accounting cash flow statement look appealing to investors and creditors.

Can Cash Flow Help Pay Off Debts Faster?

A healthy state of cash flow can certainly help you pay off your debts faster if that’s your priority. As well as being comfortably able to cover the monthly repayments, you can use some of that extra cash flow to make increased payments.

How Does Cash Flow Help Attract New Investors?

Your cash flow financial statement is an indicator of whether or not you are a good risk for investors. Being positive will certainly help you get the investment you want and also boost your credit score.

How Can a Business Get Started Improving Cash Flow?

Freeing up cash doesn’t have to be difficult. There are simple steps you can take to increase your cash flow:

Strategies for Improving Your Company's Cash Flow

One of the quickest and easiest strategies to implement is to review and improve your accounts receivable. Automate your invoicing system so that it sends invoices on time and automatically sends reminders.

Incentives for customers to pay early and on time are also great strategies. For example, offer an early-payment discount or bonus. Giving customers the option to spread the payments over a certain time period also helps avoid late or missed invoices.

Look at streamlining your operations to reduce costs. This doesn’t mean making your staff work more hours but rather looking at which processes can be automated to free up staff time to be productive elsewhere. Focus on spotting inefficiencies or unnecessary processes. Cutting red tape can save time and money.

Finally, review your employees’ roles to ensure they are performing the right tasks for their expertise. Verify that workloads are distributed evenly.

Common Mistakes Made with Cash Flow Management

Avoid these common pitfalls when looking to improve your cash flow:

Who is Responsible for Cash Flow Management?

The individual responsible for cash flow is either a bookkeeper, accountant, treasurer, business manager, or CFO (Chief Financial Officer). Smaller businesses and startups that may not have these individuals on their payroll will often outsource the job to a financial services provider.

When and How to Hire a Professional Financial Advisor?

If you don’t know what your cash flow situation is, then it’s probably time you got a professional to deal with your cash flow sheet. Similarly, if you struggle to determine what your cash flow is or lack the necessary financial knowledge to understand and analyze your statements, then you need to get the right expertise on board. Even if you feel like you have a good handle on your finances, a qualified individual will be able to spot areas for improvement and help you implement strategies to free up even more cash.

Once you’ve decided it’s time to take control of your cash flow, it’s time to hire an expert. EvolveCFO is the perfect option for small businesses. We provide financial assistance in all areas of accounting, including cash flow.

Our team works remotely and shares the necessary data through secure, cloud-based software so you can access it anywhere when you need it. Best of all, you only pay for the services you require with different monthly payment tiers to suit businesses at all stages of growth. There’s no contract either! Pay for our services on a month-to-month basis and cancel anytime.

EvolveCFO gives you the flexibility to have the financial assistance you need to get your cash flow in check at an affordable price point. If you like the sound of that, get in touch with us today.