Sales and profit are two very different things – as a business owner, you can find yourself without the cash to pay bills despite making sales you knew were profitable. You may also be startled to discover that strong cash flows from sales actually delivered little profit.
A cash flow forecast tracks cash flowing in and out of your business. The timing of these flows enables you to identify cash-rich and cash-lean periods. This helps in making the right decisions, such as when to buy assets or when to prepare for cash shortfalls.
"A business that runs out of cash needs to find a solution quickly to avoid going bankrupt."
Cash flow is essential to the survival of your business – arguably more so than profit in the short term. Profit may be essential in the longer-term, but in the short-term cash is needed to pay bills and operating costs.
A business with good cash reserves can survive until it becomes profitable. A business that runs out of cash needs to find a solution quickly to avoid going bankrupt.
Profit is the money left in your business after all your expenses have been paid. An income statement (also referred to as a profit and loss report) reveals what profit your business made last month or last quarter. Your profit’s detailed in two figures, namely:
Note that net profit still isn’t the final ‘bottom line’ profit until all taxes have been paid.
All businesses need profit to grow. Your profit can be allocated to (among other purposes):
The gap between a cash flow forecast and an income statement (profit and loss report) reflects the different ways business owners record financial data.
A cash flow forecast only records actual cash transactions. Cash flow can be boosted by inputs other than sales, such as:
These sources boost cash levels to fund your business, but aren’t profit.
Profit and loss statements show actual profit
Unlike the cash flow forecast, the income statement includes ‘book figure’ inputs that don’t involve cash outlays but do affect the profit calculation, such as:
These scenarios help explain the gap between cash flow and profit.
“The income statement shows a $50,000 profit, but the cash in the bank is only a fraction of this. The figures don’t match up. Where’s the missing profit?”
A common example that can raise this question is a business that buys equipment (a fixed or capital asset) for $40,000.
“We’ve been extremely busy these past few months. Sales are booming – but I can’t see any profit.”
Inexperienced business owners can easily confuse ‘being busy’ with being profitable, but there’s a very clear distinction between them. Your profit is always what’s left after all costs have been deducted.
If you haven’t calculated your selling prices correctly, your ‘thriving’ business may in fact be operating at a loss. The cash flow may seem great, but the profit and loss account reveals the true picture.
The critical lesson here is to never set your prices until you know all the costs involved. You might end up operating at a loss or at an unsustainably small profit level.
It’s quite possible to run out of cash or go bankrupt by taking on too much business too quickly, even though each sale is profitable. This is called overtrading – and businesses that sell on credit rather than cash terms are more at risk.
Cash flow is all about the timing of money inflows and outflows. If the owner expends significant cash to pay operating expenses and miscalculates the actual time to collect customer receivables, or the business is poor at collecting on overdue accounts, the business can easily use up all of its cash paying suppliers and other bills while waiting to collect amounts owed by customers.
Reasons businesses can run out of cash include:
Cash flow is all about the timing of money inflows and outflows.
If you expend significant cash to pay operating expenses and miscalculate the actual time to collect customer receivables, or your business is poor at collecting on overdue accounts, you can easily use up all of your cash paying suppliers and other bills while waiting to collect amounts owed by customers.
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