In business, there are a few standard indicators of financial health. These numbers will not only influence your own business decisions, but also that of your investors. Two of the most important among these are profit and cash flow. Profit is calculated as the amount left after all the expenses are paid. This is usually understood as an overall statistic for how a business is doing financially. However, profit can be an inaccurate indicator to rely on in many situations. Cash flow is the crucial factor you are probably overlooking.
Cash flow is the overall monetary activity in your business. Consistently positive cash flow ensures that your business maintains adequate liquid assets at hand. This is essential for all the transactions that keep your business running, such as acquiring inventory, salaries for your employees etc. In a lot of ways, cash flow is a better indicator of financial health for a business, which is why lenders and investors often turn to this statistic rather than profit numbers. Here we look at some of the ways cash flow is more important than profit:
Keeping track of transactions
When dealing with multiple types of business transactions, profit statements can be misleading about the revenue at hand. This is because transactions that are yet to be processed or credited to your company's account can still show up on your sales record. This might reflect a financial status that is larger than reality. In these situations, keeping an eye on cash flow is important. Cash flow numbers will keep you aware of the balance between your receivables and payables. This way you can make more informed business decisions.
Positive cash flow indicates sustainability
One of the biggest issues with profit statements is that it takes into account hard assets that are not immediately accessible. This means that even if the company has surplus money at the end of sales, the money is not immediately useable. This might seem deceptively harmless especially in view of your long term business goals. However, without adequate liquid money at hand, businesses will struggle to pay off day-to-day or monthly utilities and expenses that are necessary to keep the business afloat. Without money to bring in new inventories or replenish stock, your business can go under for eventual lack of sales or accumulate too much debt to handle.
Additionally, cash flow also keeps track of external payables such as public liability. Businesses can go under in no time owing to legal payments that they are not prepared for. Liability insurance policies take care of such predicaments. Public liability insurancepayments must be taken into account when calculating cash flow as well. Ensuring positive cash flow can help you keep track of your day-to-day financial health, which will then pay off long term.
Positive cash flow attracts investors
A company that has a steady, positive cash flow is more attractive to investors compared to, say, a company that shows profits but has uneven cash flow. This is not to say that profit does not matter to investors. However, profit is a long term goal. Cash flow reflects the exact current situation of your business. It is also a more accurate indicator of its potential for growth. Unless you have money at hand to expand, your business might not seem lucrative for investors.
Lenders often consider cash flow statement a more reliable factor to help recognize financial risks than profit statements. This is because profit statements are easier to manipulate and mislead. The hard assets that feature into the calculation of a company's profit can reflect a better financial health than reality. Cash flow reports on the other hand, are straightforward and easier to analyze.
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A reliable factor for business growth
Expanding your business is an important part of business growth. This involves taking calculated risks and making accurate predictions about the future of your company. Cash flow numbers are reliable predictors in this case while profit numbers are not. This is because, while profit depends on fluctuating variables, cash flow is a steady indicator of business sustainability. A company with consistent positive cash flow is a safe bet.
In the early days of expansions it can be misleading to look at profit numbers. What might seem like a loss at this time might eventually bring larger profits. In fact, investing additional capital might be necessary to boost sales during the expansion period. During this period, the company must have enough liquid assets to sustain itself without significant returns, to ensure survival. Instead of focusing on the small profits and losses, it might be wise to focus on balancing the cash flow long term. Hesitating to invest in expansion for fear of loss can stunt your business growth while expansion which depletes your capital beyond recovery can make your business go under. Maintaining the balance is key.
Profit is often considered the key factor in business. A profit focuses business plan is considered most likely to succeed. However, it is important to keep in mind that cash flow is the lifeblood that keeps your business running. Maintaining a strong cash cycle can ensure survival even when the short-term profits are low. The key is to keep the balance.
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