Perhaps one of the most frequently asked questions in the world of business is: should I focus on profit, or make cash flow my priority? Although they both play critical roles in your business success, there are some points to be made in cash flow’s favor. So, don’t fall into the trap of putting all your efforts into making profit, since it is not the main indicator of a successful business. There is no denying it is crucial when observing the bigger picture and long term benefits, but while trying to stay afloat in a sea of corporate sharks, you need stable cash flow to maintain financial health.
The difference between profit and cash flow
These two different financial parameters have a certain impact on your business. Cash flow is the money that goes in and out of the company from various investing activities. You need it to meet your current needs and obligations. On the other hand, profit is the money that remains from sales revenue after all the business’s expenses are subtracted.
To put it in more specific words, if a contract is worth $60,000, and it costs your company $40,000 to provide a good service, your profit will be $20,000.
We can use the same example for cash flow. If your client decides to pay you in two stages of $30,000 each, you will send the first invoice and expect your first payment in about 30 days. A month later, you will send the second invoice and like the previous, expect it 30 days after. Assuming you receive the money on the exact due date you will have the cash inflow you need to keep your business running.
The importance of cash flow
Have you ever heard of the expression “cash is king”? Well, there is some good reasoning behind it. Without cash, how could you be able to pay staff and buy the necessary equipment and material for your job? Besides, every business reaches a moment when sales are in a slump, and there is no profit in sight. In that case, you need the cash flow to keep you afloat.
When cash flow is slow
It’s never a good thing when there is not enough profit, but when there is not enough cash flow, that could question the existence of the entire company. After all, employees will not be willing to work for free and your company will not be able to provide services that require previous investments in material and equipment. The cash flow squeeze can happen for various reasons:
- Slow-paying customers
- Seasonal fluctuations
- Need for quick capital in order to pay contractors, suppliers and service providers
- You need the capital for business growth
If one of these situations occurs to you, you can always check out some invoice finance options that can fund your cash flow whenever you need it. This way you can shorten the period of waiting for invoices to be paid, because the company you choose will advance you the cash.
Business boom – cash flow dependence
In 2014 Inc. magazine published an article about three business owners who were faced with the problem of cash flow squeeze that happened during the period when their businesses were booming. On the surface, fast growth seems as a good thing. However, when a small business grows from hundreds to thousands of transactions per month, it makes the managing team lose their grip on finances. The thing is, when businesses grow, they become more complex, and some rules about billing and invoices become different. Meanwhile, more cash is needed to cover higher taxes, inventory, compliance expenses and debt. So, yes, ironically, as your sales go up, your cash can go down, and this can get you into serious trouble. In order to make it through the business growth, you will need a stable cash flow. The easiest ways to do that is through a proper accounting system and invoice financing.
Both profit and cash flow are important financial parameters, but if we would have to give an advantage to one of them that would definitely be cash flow, because without it, your business would be doomed.