Cash Flow and Profit are two concepts that are often misunderstood, particularly by business owners who are unfamiliar with the accounting techniques used for recording Sales and “Accounts Receivable” when running a business.
It is possible to make a Profit and still be caught in a cash flow bind. And the cash flow problem could put you out of business in spite of the profit.
Cash Flow is Very Different from Profits
Profit represents the excess of your revenues over your expenses. Put simply, your Sales revenue in any given time period exceeds your business expenses for the same period.
Cash Flow represents the actual flow of sales receipts and cash disbursements in your business. You receive payments for your Sales and deposit those payments in your account. You then make disbursements for your expenses.
If your expense disbursements are less than your receipts, your cash flow is positive.
If disbursements are more than your receipts, your cash flow is negative & must be covered by borrowing or by some other means.
Keeping Both Profit and Cash Flow Positive
To succeed in business, you need to make a profit and you also need to have positive cash flow.
Actual business losses will ultimately create cash flow problems – that’s pretty obvious.
But here are some typical scenarios that can sneak up on you to create cash flow problems:
• Letting your Accounts Receivable aging get out of control will ultimately hamper your cash flow.
• Building up inventories that are paid for with current cash can be problematic if there is much of a time lag between the purchase of the inventory and the sale of the products.
• Investing in fixed assets such as capital equipment, tenant fit-out, office furniture or equipment expenses can use up significant amounts of current cash, so proceed carefully.
• Not keeping accurate records about project and business expenses can make it seem as if there is more cash in the business than there actually is.
• Incorrectly accounting for deposits on projects can also backfire. When you receive a deposit at the beginning of a job, your expenses for the job have not yet been recorded, so your cash balance includes money that is probably already committed to expenses that aren’t yet showing on the books.
Don’t Get Caught Short
To stay on top of cash flow:
• Keep accurate business records and remember that competent Bookkeepers are good business investments.
• Be clear about your payment terms with your clients & stay on top of your collection process. A good bookkeeper can help with that too.
• Run credit checks on your clients before extending them credit. If they can’t pay you, their cash flow problem will quickly become yours.