Have you ever wondered what is difference between Profit and cashflow? Which of the two do you think is more critical?
Let’s first look at the definition if each:
Profit
Profit is defined as the difference between your business sales and business expenses. The trick here is to recognised that even if you sold to a customer on credit and they have agreed to pay you in 2 months, that sale forms part of the profit calculation even if the cash has not yet been received.
Cashflow
On the other hand, cashflow is the net flow of cash into and out of your business through these 3 main sources:
1) Operating activities
Normal business operations when cash is received from your customers or paid to your suppliers by you.
2) Financing activities
Investors, banks or other sources of finance who pump money into your business. The cash outflow would be when you pay back these investors or banks.
3) Investing activities
If your business has other sources of income from investments, for example if it owns real estate and receives rent from it, or if it has invested in bonds and is now receiving interest.
Now that we know what Profit and Cashflow mean, which one is more critical?
I like to use an example of a debate I had with some friends a while back. What is more critical– the heart or the brain? I guess the actual questions is which one can the best surgeons and medical professional replace and retain YOU? The heart or the Brain?
In my very simplistic way of thinking, the heart can be replaced allowing YOU to carry on with your day to day activities. However, the brain – not so much. It would not possible to retain YOU if it was replaced.
So I consider Profit to be like the heart – because you can be loss making but if you have cashflow, you can sustain your business operations. This scenario is common in startups and businesses in the growth phase. But sometimes, businesses which are declining or which have something wrong also experience this. So it’s important to analyse and understand what is driving the loss in your business. But the presence of cashflow will buy you time.
Cashflow is like the brain. If your business has no cash, it simply dies. If you’re business is profit making, but you can’t pay your rent, employees, or suppliers then that’s game over!
So as a business owner, I would advise you prioritise your cashflow over your profit.
That means:
1) Negotiating shorter payment terms with your customers so that cash comes into your business quickly.
2) Offering discounts to encourage early payment. For example, if you pay today, you can take advantage of our 10% discount.
3) Negotiating longer payment terms with your suppliers. That is, can they sell to you on credit and then you pay them after 30days for example.
Cash is King indeed and that’s because it is the brain of the business. If it dries up, your business dies. It’s that simple.
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