Profit versus Cash

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03 / Oct / 2011

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Understanding the Difference between Profit & Cash

Cash viability is the acid test of your business.

It’s what will make you or break you.

Being able to understand cash, and to generate and manage cash is the most important financial skill.

If you cannot generate a sustainable long-term cash surplus, then you will not be a business success.

What profit or loss are you making? It is essential that you understand what profit means.

However, cash is king not profit – profit is an indirect measure of the generation or utilization of cash.

Both are crucial indicators of business success and you have to put procedures in place to control and measure them both, reliably and frequently.

Cash and profit are the same thing after the transaction is complete. In business its easy to loose sight of this relationship, it becomes clouded by:

• loans
• amounts owed to suppliers
• amounts owed from customers
• taxes
• investment in equipment, stock, etc.

It often comes as a surprise to people to realize they can make a profit yet still run out of cash.

In fact this situation is common. The cause is usually:

• investments in stock – you pay for it now, but sell some time in the future

• you pay for equipment – which is not charged to profit all in one go, but depreciated and charged against profit over several years

• your credit control starts drifting – customers take longer and longer to pay you

Conversely, you can be making losses but still have cash available:

• using up stock – you may be selling to little to cover costs but you are converting it into cash

• customers may be paying now for sales you made several months ago – your current sales volume may have fallen

Sometimes these effects can be gradual, sometimes you can get a very nasty jolt – a significant loan may come due for repayment, or a large tax liability may become due.

You have to be aware of these affects and be able to anticipate and quantify exactly when they apply to your business. If you ignore these facts they will catch you out.