Why Cash Flow Is More Important Than Profit!
What do you think is the most important thing a business must generate to survive? If you asked the majority of people this question they’d often respond with one word, profit. Actually though, there’s something far more important for a business to remain successful and stay afloat than profit and that’s cash flow.
Whether you’re a small family run business or a large multinational corporation, you won’t be able to stay trading for long if you don’t have good cash flow. All businesses need to have cash available to pay bills, wages, suppliers, employees and the list goes on, but why is cash flow more important than profit?
Profit is extremely important to any business but profit is really irrelevant if you’re not getting paid for the products or services you’ve sold, consider the following examples.
Small Business Owners
Let’s imagine a self-employed plumber who works on his own wins a small public sector contract to install 50 boilers in council properties. Each boiler he fits will result in a £1000 profit for his business. The terms of the contract state that he will only receive payment once all 50 boilers have been installed and tested. The problem is it may take him 12 weeks to fit all 50 boilers. In the meantime he has to pay for his day to day expenses, business expenses and perhaps even supply the boilers.
You can likely see why cash flow is more important than profit in this scenario. If the plumber fits 5 boilers he has in theory made £5000 in profit, however he won’t actually make any profit until the contract is completed, so he’ll need to have cash in the bank to fund the contract to completion. This will likely require the plumber to have been paid on time from previous jobs or contracts. That’s why cash flow is so important for a small business, especially in times like ours when credit is so hard to come by.
So what about big business?
The recent credit crunch showed up just how important cash flow is to big corporations. Most large corporations rely on credit, even the banks can’t operate properly without it. When the availability of credit dried up during the credit crunch, banks couldn’t borrow from each other, corporations couldn’t borrow from the banks and as a result these corporations suddenly found themselves facing overnight collapse because they couldn’t pay their suppliers and employee’s, why? These corporations were very profitable establishments but as you can see from their online trading information, they were unable to cope with the disruption to their cash flow and found themselves facing insolvency.
All businesses rely on cash flow and if they don’t have it profit is irrelevant.
How can businesses improve cash flow?
There are a variety of methods a business can use to improve its cash flow. One way that is fast disappearing for a lot of small businesses is to have access to good lines of credit. If a business is finding credit harder to come by, then other options need to be explored.
One way to improve cash flow is to offer early settlement discounts, this would give customers a small discount if they were to pay their invoices in full by a certain date. If you are a small business then using online accounts software such as Xero can really help you to stay on top of your invoices and allow you to keep a keen eye on your overall financial position.
Some companies also manage to stay liquid with invoice factoring. Invoice factoring involves selling unpaid invoices on to a 3rd party at a discount, the 3rd party then attempts to collect the outstanding invoice. When they manage to collect the invoice they then forward the remaining money on to the business owner, less any fees that have been agreed for their services.
Another thing a business can do to improve cash flow is to resolve any invoice disputes quickly.
No Cash Flow, No Business
An unprofitable business can survive for a reasonable length of time as long as it has good cash flow; a business that doesn’t have good cash flow can be dead within weeks.