If your company is cash flow positive, you may think that means that the company is profitable. While inflow of cash is closely related to profit, the two terms are not mutually compatible.
It is no secret that both cash flow and profitability both play a huge role in the lasting success of a company. It is important to understand the difference between the two in order to maintain proper cashflow management
Cash Flow Positive vs. Profitability
When a company is cash flow positive, it means that the total amount of cash that the company is taking in is more than the total amount of company expense. Profit is similar. In order for a company to be profitable, more money needs to be coming in than going out.
If your company is taking in more money than it is putting out, it can be easy to assume that this means that your company is profitable. However, your business can be profitable without being cash flow-positive—and you can have a positive cash flow without actually generating a profit.
Understanding Cash Flow
Your cash flow is the money coming in and out of your business on a day to day basis. This working capital is what you use to cover your business expenses, such as payroll, rent, inventory purchases etc. Maintaining a current record of these transactions are essential for maintaining goof cashflow management practices.
Profit, on the other hand, an accounting term that only really exists on paper. This gives you a basic idea of how much money you have coming in and going out of your business each month, but what it doesn’t do is tell you much about your daily operations.
many businesses use a practice known as accrual accounting, which means your revenue and expenses are recorded whether the actual cash has changed hands or not.
For example, if a company invoices a client $2,000 for services rendered. This $2,000 will be recorded on your profit and loss statement as a profit, even if you haven’t received payment for said invoice right away.
The difference becomes evident when your bills are due. If you’re still waiting for the invoice to be payed, you may not have enough cash on hand to cover the costs. When a company does not have the cash on hand to pay their bills, makes you cash flow-negative. However, because profit doesn’t tell you exactly when money is flowing in and out of your business, you will still appear profitable on paper, even if that money isn’t currently available for spending.
Calculating Cash Flow
In order to calculate the cash flow of your company, it is important to take account of all available cash assets that your company has starting from the first of every month.
Once you know how much cash your company has on hand, you can then begin to budget expenses such as operating costs and bills, and any other regular expenditures. You’ll subtract all your operating expenses, investment activities, and financing activities. However, these figures should only take into account the cash that is available for use, so this will not include any unpaid debt or outstanding invoices from clients and customers.
Calculating Profitability – Cashflow Management
There are two major components to calculating your profitability: your gross profit and your net profit. Your gross profit is equal to revenue, minus the cost of goods. Your net profit is equal to gross profit, minus the cost of operating expenses.
Gross profit is the amount of profit made from sales, but this calculation does not include the other costs associated with running a business, such as payroll, rent, marketing, and so on. In order to figure out your total profitability, you need to calculate your net profit.
To do this, simply deduct the cost of overhead expense from the total profit that you bring in. This will allow you to get a better picture of your company’s financial standing, and allow you to better account for success.
Conclusion
As you can see, while there is some similarities and overlap between profit and cash flow, the two are not synonymous. Profitability takes a look at your financial circumstances and gives you a general overview of the bigger picture of your business’s finances without giving attention to all the minute details. On the other hand, your cash flow calculations monitor your receivables and payables in real time, allowing you to stay on top of your monthly financial situation so you can keep operating your business from day to day. To learn more about cashflow managment solutions for business, contact excellent admin today.