Profit and cash flow are both important elements of a healthy, growing business, but they are not the same thing. Profit is revenue (the money made selling your product or service) minus expenses (what it costs to run your business). It can also be referred to as net income. Cash flow, meanwhile, refers to all cash going in and out of your business. While profit is good and important, cash flow is what will allow you to pay employees, pay for manufacturing, and pay for anything that allows you to actually run your business. Basically, profit means you’ll have money in the bank, but cash flow means knowing when that money will arrive and when you’ll have to spend it on future expenses.
Now that you know why cash flow matters, let’s go further into why it’s important to monitor your business’ cash flow instead of just celebrating its profits. While some businesses get paid in cash or transferred money for their sales immediately, others make a sale and have to wait for the cash to actually arrive so they can collect their profits.
Imagine Zara’s Zesters, a manufacturer that distributes citrus zesters to kitchen stores. It costs $7 for Zara to make a zester. She then sells each one for $10, which gives her a $3 profit. If customers pay her $10 immediately, that’s great. However, Zara has the type of business where customers pay her 30 days later, so she has to wait to get the cash. And that’s cash she needs to pay to manufacture the zesters in the first place. Say a new store contacts Zara and offers to buy 500 zesters. Excited for the huge sale (and huge profit), Zara accepts this offer only to then realize she doesn’t have enough cash on hand to produce such a high volume of zesters. This rapid increase in sales has put Zara in a cash flow crisis – she doesn’t have enough cash on hand to pay for what it takes to keep her business running.
In a cash flow crisis, business owners may have to quickly sell stock or find a lender to raise cash – not a choice they’d normally take. They might sell more or pay a higher interest rate on a loan than they’d prefer, which isn’t ideal either. If Zara had planned for an increased outflow of cash spent on manufacturing costs, she wouldn’t have to worry about taking out a loan or giving up part of her ownership in the company, all of which will hurt her profits eventually.
To help prevent a crisis, you’ll want to have a cash flow management system in place. This way you can avoid spending cash that you don’t currently have. Even if your business receives cash for sales immediately, you’ll still need to pay expenses like rent and employee payroll. You might keep a calendar of when payments for various expenses are due so you’ll have the cash to pay them.
If Zara’s calendar says she has to pay manufacturers $3500 by June 1st , she can make sure she has that amount by that date, and, knowing her top customer typically takes 30 days to pay an invoice, send out an invoice a month in advance. Since Zara’s Zesters has to wait for cash to arrive after a sale, she might also ask customers for a deposit on their order to help cover the cost of manufacturing – half the cost upon order and half upon delivery is often standard for a deposit.
In general, cash flow management is about monitoring the cash you’re spending, knowing when you’ll get it back, and considering what you might need to spend it on again.
Now that let’s review which of your expenses you might need to be more aware of.
Think about the cash you’re spending – and what you’re spending it on – is key for a healthy, growing business. Next, think about where you can cut down on costs and make your business run even smoother.
Curated by Intuit
An easy way to begin with tracking your business finances is to get to know the 3 basic financial reports that can help you to evaluate your business’ financial health.
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