Cash Flow + Your Business
We talk ALOT about profitability, but that's not the be all and end all when it comes to healthy businesses. And, while cash flow and profitability are very much tied together, they are not the same thing. Having a handle on both is critical to business health. We took a dive into profitability in Season 1 of our podcast. Now we are stepping a bit into the next layer: cash flow.
What is Cash Flow?
Cash flow is (generally) not the same as profitability even though you may hear them used interchangeably. Depending on your business, this might be OK or it might be highly misleading. Keeping them as separate measures - even if they are sometimes really close to the same number - helps eliminate any confusion. Trust us.
In business, cash "flows" in both directions. It flows IN to your business from customers or clients who are buying your products or services. It flows OUT of your business for expenditures, such as rent, loan payments, taxes, business supplies, and payroll. The difference between the INs and OUTs is net cash flow...and it can be positive or negative.
Cash Flow vs. Revenue
Revenue is the cumulative sum of money that is coming into your business (this assumes a cash basis for simplicity). You can sell your products like hot cakes, post impressive revenue, and still not have a healthy business. Net cash flow, as discussed above, is tracking the sum total of those sales, as well as the bills you paid for supplies to make those hot cakes, advertise them, pay the staff that sold them, the taxes due from those sales, and the rent on the retail space you sold them from. Cash flow also takes into account INs and OUTs that don't hit your P&L: proceeds from a bank or private loan, payments on those same loans and payments for equipment to name a few.
Cash Flow vs. Profits
Profit is whatever’s left of the money you brought in (your revenue) after you deduct the money you send out (expenditures.) So how is that different than cash flow? Good question.
Let’s say you own a landscape design firm. You’ve just completed a major commercial project. You had upfront expenditures for plants, sculptures, walkway pavers, and fountains. The deposit you received for that project covered those expenses. You’ve billed your client for the balance of the payment and now you wait for their check. They’ve got 30 days to pay, per the terms of your contract. On paper, the cost of labor and supplies is less than what you’ve charged to complete the job. You’re going to clear a profit on it, just like all your other jobs. Right now, however, the only place that profit is appearing is on your books because until that invoice is paid and the check clears, you don’t have the cash (or the cash flow). If this is your first big job it may mean that you’ve laid out some of the cash earned from your other jobs to cover payroll and other regular expenses. Maybe the checking account is getting smaller by the day as you wait for the check from that big job to hit the balance sheet. You’ve earned a profit, but you could still be dealing with a negative cash flow until that receivable is paid to you.
Why Does This Matter?
The majority of failed businesses can point to poor cash flow as part of the reason they did not succeed. Revenue says you’ve got something (at least some) people want to buy. Profit says people are paying more for it than it costs you to make. Cash, however, is the true reality of your business. It’s the measure of your business’s health. Healthy businesses learn how to manage their cash flow so that at any point in time, the amount going out does not exceed the amount coming in.
For an investor, lender, or buyer taking a hard look at your business, your cash flow is an indication of whether or not you can weather unexpected expenses or a slowdown in sales. It’s a barometer of whether you can afford to grow the business, offer a return to shareholders, or pay off debt.
But even leaving those outside audiences aside, cash flow is a huge factor in whether you are battling sleepless nights worried about making payroll (or not). Worried about if that check is coming tomorrow (or not). Worried about if you pay the rent that is due on the first (or not). All those worries keep you from focusing on other key parts of your business...and your life.
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