Cash flow vs profitability.
We all know that understanding cash flow is vital to the success of your business.
And having cash reserves is important to make sure you are never left short at crucial times, such as when wages are due, and when tax and loan repayments needs to be paid. Or, as 2020 has shown us, if the unexpected occurs.
That’s why it’s important to be able to forecast your business’ cashflow.
An accurate cash flow forecast should take into account your business’ current performance across revenue, operating costs, payment habits of both, financing commitments etc.
It should also include what you know about future trends and seasonality.
Cash flow vs Profitability - What’s the difference?
Having positive cash flow is different to being profitable.
Positive cash flow means your revenue comes in on time to pay your expenses and keep you from running out of cash.
Profitability means your revenue is greater than all the expenses required to keep your business generating that revenue.
Basically, timing is the difference between the two.
If you sell $1,000 of goods every month and spend $500 in a month, you will make +$500 profit.
But if you’ve paid your suppliers for the $500 expenditure within the month and fail to collect the cash from the sale of goods within the month you would have -$500 in negative cash flow.
Why it's important to understand the difference between cash flow and profitability
Unfortunately, many businesses fail due to poor customer payment collections, and not understanding the difference between profitability and positive cash flow.
It’s important not to rely on a profit showing in the Profit and Loss statement, as it is more reflective of positive cash flow than actual profit.
When relying on your bank balance and the P&L to indicate your business performance, you are at huge risk of forgetting all of the items you are responsible for “below the fold” on the Balance Sheet.
Often, the biggest, lumpiest cash out flows that you are responsible for appear there: GST, payroll taxes, loan repayments etc.
This is why it’s important to implement forecasting in your business. A great option to implement forecasting is Futrli.