Do you get confused by the disconnect between profits and cash in your business? If so, you’re definitely not alone. A lot of business owners get frustrated by having only one or the other – but not both. Honestly, the whole cash flow vs profit thing is confusing.
It’s weird to think the business bank account could have plenty of money when the company is operating at a loss. Or that your business is wildly profitable – at least on paper – but the bank account is practically empty.
A healthy business has plenty of profits and cash flow. But that doesn’t happen overnight. It takes time to build up both. By focusing on each individually, you’ll have an easier time increasing both.
That’s because the steps needed to boost cash are different from the steps needed to boost profits. Sometimes they work in opposition, so you’ll have to prioritize. And while the instinct is to put profits first, no business can survive without cash—cash is the higher priority.
Cash Flow vs Profit from an Accounting Perspective
Cash flow describes the way money moves into and out of your business. That cash can come from or go to three main activities: operations, investing, and financing. In the beginning, most small business cash comes from the financing section, but the goal is to generate positive cash flow primarily from operations.
Operations
Operations refers to sales and expenses, the everyday money moving in and out in the normal course of business. These can often have surprising – even confusing – effects on your cash balance.
For example, increasing sales doesn’t always increase cash flow due to invoicing and payment delays. Reducing expenses can increase cash flow, even if not immediately, but can make it harder to run the company if they’re cut too deeply… and that can lead to future lost sales.
Investing Activities
Investing activities refer to investments made by your business, like buying assets. This includes buying things like delivery trucks, computers, and software. If you later sell those assets, the cash coming in count toward investing activities too. Many small businesses will have minimal investing activity.
Financing Activities
Financing activities include loans and investments into the business. For example, it includes the money you and other owners (such as partners or shareholders) put into the company or loan proceeds received from a bank. This includes getting money from lenders, such as vendors and credit card companies, and paying money back to them.
It would also include money that you (as the owner) have loaned the company and expect to be paid back, as well as payments back to owners in the form of dividends or distributions.
The Downside of Boosting Cash No Matter What
Cash is the lifeblood of your business. It cannot function without cash resources. So it can be tempting to get cash in the door any way you can.
A lot of small business owners pull from their personal savings and retirement accounts, or borrow money personally (like a home equity loan) to fund their businesses. They try to get any and as many loans as they can, even if terms aren’t good – like super high interest rates. They might slash prices to get more customers in the door or cut expenses down to the bone, often by trying to do everything themselves (from bookkeeping to advertising to customer interactions).
All of these can help fund the business, at least temporarily. But they can also undercut future profitability and future personal financial security. So it’s important to go into this with a proactive plan rather than having to react every time there’s a cash crunch.
Profits (or Losses) on Paper
Profits (also called net income) come from a simple math formula: revenues minus expenses equals profits, or losses if the result is negative. This number tells you whether your business is bringing in enough revenue to cover all of its operating costs.
It’s normal for a new business to be running at a loss for a while. It takes time to build a customer base and generate enough sales to outweigh the business expenses.
Your business can show profits with or without having enough cash on hand. So having a profitable business does not mean money in the bank. That’s because profits often include some noncash transactions that affect the bottom line, such as:
- Accounts receivable: Invoicing customer accounts for goods and services sold to them for which payment hasn’t been received yet.
- Depreciation: An accounting method of expensing an asset slowly over time, for example expensing a $10,000 machine for $1,000 per year over ten years instead of the whole $10,000 at the time of purchase.
- Accrued expenses: Recording the purchase of goods or services used by the business but not yet paid for, such as year-end bonuses paid out in the following calendar year.
- Prepaid expenses: Recording expenses as they are actually used rather than when they get paid, for example paying a six-month insurance premium in January and spreading the expense evenly in all the months from January through June.
Most of these transactions involve cash at some point but not at the time the transaction has been recorded for bookkeeping purposes. And all of these will affect the profits on paper without having any current impact on cash.
Five Quick Ways to Boost Business Cash Flow
There are effective, simple steps you can take to improve your company’s cash flow without decimating your profits. Some of them may ding profits slightly and temporarily, but they can be easily altered once the incoming cash flow becomes steadier. All of these methods can be implemented quickly to help boost cash as quickly as possible:
1. Invoice customers immediately. They can’t pay you if you haven’t billed them.
2. Offer early-payment discounts. Let customers know that if they pay you within five days (or three or ten, whatever works for your business) they’ll get a small discount, usually around 2–5%. Depending on your business, you might be able to offer prepayment discounts, where the customer pays up front for 5% off a project you’re doing for them.
3. Make it easy for customers to pay. Offer as many payment options as you can, including credit cards and payment processors like PayPal, even if you’ll lose a small percentage of your revenue in processing fees.
4. Reduce non-essential spending. Any expense that is not essential for keeping the business running (like a website redesign) can wait until you have more cash available.
5. Delay vendor payments. If your vendor offers thirty-day payment terms, don’t pay them sooner, even if you’ll lose out on a discount, because right now cash flow is more important.
These short-term strategies can give your business a quick cash injection. Longer term strategies include focusing on things like efficient inventory management, leasing assets (like trucks or production equipment) instead of buying them outright to preserve current cash, and parking any extra cash into high-yield savings accounts.
Want to Learn More About Profitability vs Cash Flow?
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