Investors and business owners are often in search of a single metric for understanding the health of a company. They want one line item in a financial statement to determine whether they should make an investment or adjust their business strategy. In these instances, cash flow and profit are often pitted against each other. But which is more important?
There isn’t a simple answer to that question; both profit and cash flow are important in their own ways. As an investor, business owner, employee, or entrepreneur, you need to understand both metrics and how they interact with each other if you want to evaluate the financial health of a business.
WHAT IS CASH FLOW?
Cash flow refers to the net balance of cash moving into and out of a business at a specific point in time.
Cash is constantly moving into and out of a business. For example, when a retailer purchases inventory, money flows out of the business toward its suppliers. When that same retailer sells something from its inventory, cash flows into the business from its customers. Paying workers or utility bills represents cash flowing out of the business toward its debtors. While collecting a monthly installment on a customer purchase financed 18 months ago shows cash flowing into the business. The list goes on.
WHAT IS PROFIT?
Profit is typically defined as the balance that remains when all of a business’s operating expenses are subtracted from its revenues. It’s what’s left when the books are balanced, and expenses are subtracted from proceeds. It’s the equation of:
Income – Expenses = Profit
Profit can either be distributed to the owners and shareholders of the company, often in the form of dividend payments, or reinvested back into the company. Profits might, for example, be used to purchase new inventory, for a business to sell, or used to finance research and development (R&D) of new products or services.
WHAT’S THE DIFFERENCE?
The main difference between profit and cash flow is that profit measures the profitability of the business model while a cash flow statement shows where your money is coming from, where it’s going, and how much cash you actually have on hand at a given point in time.
The problem with cash flow for many business owners is that it tells you where your money went.
But what if you flipped the script and YOU tell money where to go? In this scenario, the equation would look like this:
This forces you to be much more vigilant with the expenses you incur.
WHY PROFIT SHOULD BE PRIORITIZED?
in the equation of “Income – Profit = Expenses”, this focus is making profit your priority. (Because isn’t that why you went into business?) The idea is that you set aside a certain amount of your income as profit first before paying any other expenses. That means that you account for profit before payroll, utilities, inventory, etc.
When you prioritize profit in your business, you can “be profitable” after your first sale. This is because you allocate a percentage of income for profit and pay your expenses with the remainder.
On paper, this is all just numbers. However, the mental boost that comes with seeing a profit account begin and grow is tremendous. Try reading these two statements out loud:
I’m working really hard and not seeing a dime for my efforts.
VS.
I’m working really hard and am already seeing a profit.
See how different it feels just to verbalize your profitability? It’s empowering and encouraging and motivating. There is no need to get hung up on the amounts or percentages at this point. The power is in knowing that you are profitable right away. With this mindset shift, your business can thrive, and that bank account will continue to grow.
SHOULD YOU PUT PROFIT FIRST?
This shift in mindset and methodology has helped over 300,000 businesses worldwide survive and thrive and create longevity. It enables business owners to:
- Become profitable immediately
- Become vigilant about expenses
- Stay in touch with your money
- Be ready for growth opportunities
If you are interested in learning more about putting more profit in your pocket, check out our webpage on Profit First Intensive. (www.SaundersTax.com/ProfitFirst.php ) During this 10-week program, you will be taught the methodology to implement this system into your own company as well as receive private, one-on-one coaching to help you determine you allocation amounts.
Contact our office at 301-714-2071 or visit www.SaundersTax.com for more information. We have been helping small business owners experience a Less Taxing Life and More Prosperous Solutions since 1984!
