Which is more important, cashflow or profits?

It goes without saying that the goal of every business owner is to operate a profitable business. Being able to pay the bills when they are due and having some residual income at the end of the period is a satisfying feeling. With that in mind, business owners wrestle with the question of, what’s more important Cash flow or profits.

What Is Cash Flow?

Cash flow is the inflow and outflow of money from a business. It is necessary for daily operations, taxes, purchasing inventory, and paying employees and operating costs.

Positive cash flow indicates that a company’s liquid assets are increasing. This enables it to settle debts, reinvest in its business, return money to shareholders, pay expenses, and provide a buffer against future financial challenges. Negative cash flow indicates that a company’s liquid assets are decreasing.

What Is Profit?

Profit is the surplus after all expenses are deducted from revenue. Profit is the overall picture of a business and the basis on which tax is calculated.

There are three major types of profit that small business owners should pay attention to : gross profit, operating profit, and net profit. The business owner is provided meaningful insight when each type of profit is understood and analyzed and thus can make informed decisions that will aid in the company’s profitability.

Each type of profit gives the owner information about the company’s performance, especially when compared against prior operating periods and other companies in the same industry. All three levels of profitability can be found on the income statement.

Which One Is of Greater Importance to a Business?

When determining which one is of more importance, one has to take each business individually and evaluate and analyze its operational and financial position to make such a determination.

For example, a business may see a profit every month, but its money is tied up in hard assets or accounts receivable, and there is no cash to pay the daily operational cost of the business, i.e. employee salaries, electricity etc.

Once the company collects on those accounts receivable the business sees an influx in revenue, it starts to see positive cash flow again. In this example, cash flow is more important because it keeps the business running while still maintaining a profit. Alternately, a business may see increased revenue and cash flow, but the company has a huge amount of debt, so the business does not make a profit.

In the long run the absence of a profit eventually has a debilitating effect on the cash flow. In this instance, profit is more important. Another thing to remember when determining whether to focus on cash flow or profit, is the fact that there can be an infusion of cash into a business from external sources. A business owner can put up his or her personal assets as capital into the business. A small business loan can be secured from a bank to keep the business running until it begins to cash flow again.

Cashflow and profits are both crucial aspects of any business. In the long run for a business to be successful it must be profitable while generating a positive cash flow.

Profit is more indicative of your business’s success, but cash flow is more important to keep the business operating on a day-to-day basis. They can be viewed as a coin with two sides, both are equally important.

User | 25/02/2020