Cash is KIng

Cash is King

So it’s the end of the financial year, and your accountant reports your business has a nice profit.  You are surprised and tell them you cant understand as you have no money in the bank and don’t know how you will pay the taxes on the profit.

According to a report released by ScotPac in its latest, SME Growth Index 72.5 per cent of small business reported having cash flow problems.  Small businesses with limited financing must focus on earnings and pay attention to cash flow, the actual money resources used to support operations.  What does this mean, and how can business owners track?

Cash Flow and Profitability are Not the Same

Although closely related, cash flow and profitability are different. Cash flow represents the cash inflows and outflows from the business. Profitability represents the income and expenses of the business.

Think of cash flow as transactions that affect your business “Bank account” and profitability as items that impact your “income tax return”.

Cash inflows and outflows show liquidity, while income and expenses show profitability.

Liquidity = Can I pay my bills?

Profitability = Am I making money?

Cash Flow-Positive vs. Profitability

When your business is cash flow-positive, it means your cash inflows exceed your cash outflows. Profit is similar: For a company to be profitable, it needs to have more money coming in than going out.  So, when you see that you have more receivables than you do payables, it can be easy to assume that your business is making a profit. But that’s not always the case.

Your business can be profitable without being cash flow-positive

You can have a positive cash flow without actually making a profit.

Here’s how to see if you’re cash-flow positive:

Many businesses use accrual accounting, which means your revenue and expenses are recorded, regardless of whether or not cash has been exchanged.

For example, let’s say you send out an invoice for $1,000. This $1,000 will be recorded on your profit and loss statement as a profit—even if you don’t receive payment for said invoice right away.

This difference is critical when your bills come up as due. If you’re still waiting for payment on that invoice, you may not have enough cash on hand to cover the costs.

  • Not having the cash makes you cash flow-negative.

Since profit doesn’t tell you exactly when money is coming in and going out of your business, you will still appear profitable on paper, even if that isn’t in the bank for you to use.

How to Calculate Your Cash Flow

To calculate your cash flow, you have to know how much money your business starts with on the first of the month.

Your “cash on hand” should include precisely that—the cash you have on hand that is readily available to use.

Once you know how much you’re starting with, you’ll subtract all your operating expenses, investment activities, and financing activities.

  • Cash flow will not include any unpaid debt or outstanding invoices.

Let’s say you have five customers and you send five invoices every month.

Let’s also assume your average invoice value is $2000, and your payment terms are NET21 days.

We’ll assume your Cost of Goods Sold (COGS) is 50% of your billed amount and that your operational costs are flat at $3000 per month (including rent, employees/contractors, insurance, etc.). In this case, your cash flow chart may look something like this (not taking into account prior balance or actual cash on hand, for simplicity):

Example: Cashflow Calculator

Cash Flow Chart Month1 Month2
Issued Invoices 5 5
Value Per Invoice $2000 $2000
Paid Invoices 0 5
Booked Revenue $10000 $10000
Actual Income $0 $10000
COGS -$5000 -$5000
Operational Costs -$3000 -$3000
Monthly Net Profit $2000 $2000
Monthly Cash Flow -$8000 $2000
Running Cash Flow -$8000 -$6000

If you sent that $1,000 invoice out, but it is yet to be paid, you will not count it as a cash inflow. Instead, you’ll mark it as “collections or accounts receivables” until the invoice is paid.

Or, let’s say you purchase something with a business credit card but don’t pay it off right away. The balance you owe on your card will not count as a “cash outflow” until the debt is paid.

After your calculations, your cash flow is positive if your closing balance adds up to be greater than your starting balance. If it adds up to be lower, your cash flow is negative.

Which One Is More Important to a Business Cash or Profit?

When determining which one is more important, it depends on the business and the circumstances.

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 employees.

A business may see increased revenue and cash flow, but there is a substantial amount of debt, so the business does not make a profit.

The absence of a profit eventually has a declining effect on the cash flow.

An unprofitable business that is cash flow positive will have a hard time remaining positive for long.

Cash flow is what keeps the lights on

In short, profit can show you how successful your business is, but it can’t tell you if your business has the money to survive long-term.


Sara Pantaleo, Affari SP Founder

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