Cash vs Profit

Cash is like air; profit is like food. You need cash all the time, but you can survive, for a while, without profit.

Profit is what remains from sales after all the firm's expenses are subtracted. Cash flow is the money that flows in and out of the firm from operations and financing and investing activities. It's the money you need to meet current and near-term obligations.

Cash Importance "Cash is king" is an adage used to describe the importance of bringing cash into your business. Often, businesses spend money on salary, utility bills, and lemons before they bring in any revenue. A strong cash position helps you pay your bills and have money left over for safety or reinvestment. By plotting out when cash will come in and when it needs to be paid out, a business can identify when it needs cash on hand, and can do what it takes to make the cash available. Companies often take out loans to survive until revenue comes in.

Profit Importance The long-term financial objective of a for-profit business is making the most profits possible. On your business’s Profit and Loss statement, gross profit, operating profit and net profit all give you a glimpse of how well you are earning income from the sales of goods or services. Optimizing profits means generating strong revenue through effective marketing and solid offerings and controlling costs through efficient use of resources. Earning profits helps your business achieve its financial goals, puts money in the pockets of owners and gives you in-come to reinvest for growth.

Cash vs Profit Ideally, your company generates plenty of cash and profits over time. However, these two financial objectives sometimes conflict with each other. If you make strategic decisions to maximize cash flow, you may sacrifice short-term profit. In the same way, setting ambitious profit objectives may come at the expense of near-term cash flow.

When you’re profitable you tend to think in overly simplistic terms: “If I do twice as much of what I’m doing, I’ll make twice as much profit.” But the problem is that there will be a lot of cash going out for expansion—for buying equipment, leasing premises, hiring people, developing a finished good—and your cash might be gone before any new money comes in.

A company can be profitable and still go bankrupt from cash flow problems. If they must pay for mate-rials in January but don’t get paid by their customers until June, they need a loan to survive until June. If they don’t get that loan—even if they have guaranteed sales in June—then they will go out of business. Sometimes customers themselves will pay in advance, effectively giving an interest-free loan to a company to help cover cash flow.

For example, when we bring on a new client, we have to pay a lot of expenses associated with training that client. We have to pay for consultants, printing, and travel costs, and we are obligated to pay people within 30 days if they’ve done work for us. One particular client doesn’t pay for six months. It’s a profitable sale, but we’re not seeing that cash (and those profits) coming in for quite a while. Meanwhile, we have all the expenses associated with that relationship. It’s very painful, but in effect it’s a consequence of expansion. We have to make sure we have a strong enough cash flow to stomach the interim period while we’re waiting to be paid. Otherwise, our profits are a dream that won’t be realised.

Receivables and Payables Accounts receivable and accounts payable provide a link between cash and profits. Accounts receivable show money you have earned but haven't yet collected from the customer. Revenue on accounts improves your profit, but it inhibits your cash flow be-cause you don't get cash in hand right away. In some cases, receivables are written off as bad debt when uncollected, hurting both cash and profits. Accounts payable represent money you owe your creditors for supplies and materials. Owing money minimizes profits but actually improves your short-term cash position.

Rapid Growth and Business Failure One of the most dangerous times in business is the transition when a company is expanding and al-so expending. Financial commitments come up, the company can’t raise enough funds, and it has to sell something at a loss to raise cash winding up in a worse position than at the beginning. Rapid growth problems have contributory issues, all of them affecting cashflow, profit or both:

Operational problems: volume increases change operational requirements. Often, businesses in the midst of a growth spurt devote insufficient time to making those changes in time.

Customer service issues: new products spur sales, but often come with issues leading to expensive warrantee repairs or even product recalls. A customer service staff may not expand in concert with sales growth, which also leads to customer dissatisfaction,

Exuberant corporate spending: the success of one product may lead the company to make overly-optimistic spending decisions, such as expensive equipment purchases and imprudent facilities improvements.

Human resource problems, including a rapid in-flux of workers unfamiliar with or unsympathetic to the existing corporate culture; dissatisfaction of current staff over new supervisors, payroll problems and changes in production methods

Leadership problems: often the characteristics of a successful entrepreneur are quite different from the characteristics of a successful CEO of an established company. As a company expands beyond its start-up phase, it may require a change in leadership, which is either resisted or unrecognized in a timely way.

In a growing company, keeping track of cash flow and profit also requires attending to these related issues. Sometimes it may even become necessary to curtail the growth rate in order to assure long-term success.

Balancing Act If you have a strong current cash position, you might offer more lenient collection terms to drive more sales on account. You can also keep products at higher price points and wait on sales. If your company needs to generate cash to cover short-term debts and expenses, you might have to sacrifice profits. Offering sales promotions, for instance, helps retailers generate quick cash but sometimes at the expense of long-term profits. As a manager, you have to assess your short-term and long-term objectives to decide whether to focus on cash or profits.

1) You Need a Strategic Plan Where do you want to go? Where would you like to be at? This is the “dreamer” or vision phase of business planning; it’s necessary, though certainly not enough to fuel a business.

2) You Need A Budget Use a budget from your Profit and Loss account (P&L) to measure past profit and project it forward into the future. You must determine whether the business can be profitable before your ever worry about cash flow. Without profit, a business will never survive long-term. You can use your P&L from the last six months to determine a budget for the next six months.

3) You Need A Cashflow Forecast Budgets tell you if your expansion will be profitable, and how much profit you will make. But they don’t tell you when cash is coming in. That’s where the cash flow forecast comes in. Once you have a grasp on how to handle your cash flow needs, a) your own expectations will be as realistic as can be, and b) banks and investors will look more favorably on your business. They will know they’re dealing with someone who understands business and isn’t just a dreamer. You should be looking at least a year down the road, to know when and where money is going out and where it will come in from. That way, you’ll know how much money will have gone out before your profitable sales start. It’ll tell you how much fresh funding you’ll need beyond the profits of the business and when you can afford to start your expansion if you’re going to self-fund.

If you find there’s no way you can find the cash you need, you’ll have to go back and revisit your plans. Repeat each step until it works.

Conclusion So remember: profit is how much money you have left after you get your revenue and pay your expenses. Cash flow is when you actually get and pay the cash.

The bottom line: cash is not profit, and profit is not cash. You need both to sustain and grow a business, though not in equal measures at every point. But you never start with the cash flow. The vision starts a business, profitability helps it grow, and cash flow is the day-to-day driver. As long as you have enough cash to survive, you can comfortably expand to a more profitable business. You won’t succumb to panic when the expansion takes longer than you thought, and you’ll eventually reap the benefits of greater and greater profits.

In the long-term, you must eventually get profitable or find someone like investors to keep giving you cash to make up for your losses. In the short-term, even if you’re profitable, you survive or fail based on whether you have cash to pay the bills.

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