When it comes to running a profitable business, cash flow and profit are two of the most misunderstood financial ideas.
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When it comes to running a profitable business, cash flow and profit are two of the most misunderstood financial ideas.
When it comes to running a profitable business, cash flow and profit are two of the most misunderstood financial ideas. Many business owners think they imply the same thing, but they don't. In fact, getting the two mixed up can lead to unwise decisions, money problems, and even the demise of a business.
We at Ashmans Accounting in Adelaide know firsthand how confused cash flow and profit may hurt small businesses. Let's talk about the difference between cash flow and profit, why it's important, and how knowing the difference may help you with your money.
Profit is what you have left over after you pay your bills. It shows that your business can make money in the long run. There are three main types of profit:
Profit is what shows up on your income statement. It demonstrates how well your business is doing generally, but it doesn't always show how financially solid it is every day.
Cash flow is the amount of money that comes into and goes out of your business at any particular time. At this point, cash flow is more crucial than future income or predicted revenue.
Cash flow is made up of:
Positive cash flow means your business has more money coming in than going out. Negative cash flow means the opposite and even profitable businesses can suffer from it.
The main things that set cash flow apart from profit are timing and focus:
For example, if you bill a customer $50,000 in May, the money can show up in your accounting as profit straight away. If the client doesn't pay until August, though, your cash flow could be negative in the meantime.
Cash flow is having money on hand, while profit is making money.
Research shows that bad cash flow management is one of the top reasons small businesses fail, even those that say they are making good money. If you don't have enough cash on hand, you can't pay your suppliers, staff, or the tax office, no matter how much money you make.
Knowing the difference between cash flow and profit might help you make smarter decisions. You might want to grow if you show a profit on paper, but this could place a strain on your resources if your cash flow is negative.
Businesses that are growing quickly often run out of cash because their costs are higher than their income. Good cash flow management makes sure that you can grow without going overboard.
Cash flow decides if you have enough money to pay your taxes on time, but profit numbers affect how much tax you owe. Both must be balanced so that you don't have to deal with extra stress throughout the lodgement season.
Use accounting software like Xero or MYOB to make cash flow statements and predictions. Checking in once a week or once a month can help you find problems before they get worse.
You may get your clients to pay on time by setting clear terms, reminding them, or giving them small incentives for paying early. The faster you collect on debts, the better your cash flow will be.
Just because you make a lot of money doesn't mean you have it. You can get a good view of your liquidity by separating your accounting profit from your real bank balances.
Setting up an emergency fund protects your business from unexpected expenses or late payments from customers.
A trained accountant can help you improve your cash flow plan, keep track of your working capital, and look at your profit margins. At Ashmans Accounting Adelaide, we give businesses personalised guidance to assist them keep their cash flow and profits healthy.
Think about a little construction company in Adelaide that makes a good profit every year. It looks like it's working on paper. But the business has trouble paying suppliers and payroll every month because most clients pay their bills 60 to 90 days after they are received.
The company is at risk of going out of business because it is having trouble with cash flow, even though it is making money. The company gets back on track by setting up a cash reserve, working out better terms with suppliers, and making sure that debtors are managed more strictly.
This picture explains why cash flow management is vital and why profit alone doesn't tell the whole story.
You can't really put one ahead of the other. Cash flow is what keeps you alive every day, but profit is what keeps you going in the long run. In order to stay strong when the economy changes, strong firms keep an eye on and regulate both.
It is important to know the distinction between profit and cash flow for more than simply accounting reasons. If you mix them up, you could end up with bad management, money problems, or even the company going out of business.
You can make better choices, prepare better, and protect your business from unnecessary risks by keeping a tight eye on both.
At Ashmans Accounting in Adelaide, we specialise in helping small businesses make more money and manage their cash flow better. If you need a full financial health check, better tax planning, or clearer reporting, our experts can help.
If you're ready to take control of your money, call Ashmans Accounting right now.
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