Running a business is no walk in the park. It’s full of confusing buzzwords like ‘profit margin’ and ‘cashflow’ that, as a new business owner, you have to wrap your head around.
So, as part of our effort to help you run your business the best way you can, let’s go over what is perhaps the most important part of running a business: cash.
More specifically, let’s take a look at the difference between profit and cashflow, two concepts that are easily mixed up or misunderstood altogether.
What is cashflow and why is it important?
Cashflow is all about the total amount of money that is coming in and out of a business. Sometimes, the cash that comes in is referred to as ‘inflows’, while money spent is called ‘outflows’.
Having more money coming in than you’re spending, called a positive cashflow, means your business can keep the lights on. Spending more than what you have coming in results in a negative cashflow.
Whether you have a positive or negative cashflow depends on various factors. First, there’s what’s coming in, which will be affected by the prices of your goods and/or services and how promptly your customers pay. The quality of your sales and marketing skills can also have an impact.
Meanwhile, outflows go towards equipment, stock, rent, insurance, training and staff costs, and debt repayments.
While any business can experience cashflow problems, startups and ones looking to expand are more likely to confront a negative cashflow. As they need to grow quickly, they require a lot of investment, making it easy to rack up more outflows than inflows.
It goes without saying that a prolonged period of negative cashflow is bad news for a business. If you’re chasing invoices and run out of cash, your ability to take on new work is severely limited.
You might not be able to keep paying for certain stock or utilities. And if you can’t pay your employees and even yourself on time, it won’t be long before issues with staff retention and personal problems come up.
And that’s without mentioning the risk of compulsory liquidation if you can’t pay your debts.
What is profit and why is it important?
Some people assume that when you charge someone for a product or service, you’ve made a profit.
Sure, there’s now money in your pocket, but if all of that ‘profit’ is eaten up by staff wages, utilities and debt repayments, how exactly did your business profit from its functions?
Instead, profit is actually worked out with a very simple formula: your total revenue minus your running costs, with your revenue being every single pound you make.
If you’ve made more than you spent, then you’ve made a profit.
Profit isn’t just a perk and opportunity to pay yourself and your employees more, but an essential part of running your business if you want to keep its doors open for the long term.
That’s because investors will only want to lend you their money if there’s something in it for them. Banks will only lend if your business is healthy, and profit is a sign of a business’s health.
Profit also allows you to expand your business, whether that’s by opening in other locations, targeting other markets or growing your influence abroad. So, if you have aspirations for your business, making sure it’s as profitable as possible is essential.
How to improve cashflow and profit
Now we understand what cashflow and profit are, and what the differences are between them, how do you improve them?
Improving cashflow should always start with a cashflow forecast. This will map out your projected inflows and outflows based on previous data. The best will also include different predictions based on different assumptions, like a better than expected year of sales and rising utility costs.
They can be difficult to put together if you’ve never done one before though, so don’t hesitate to reach out to us for some advice.
After that, you’ll be ready to implement some strategies to improve your cashflow, which we’ve dove into in great depth with a previous blog article.
What about your profit? Business planning, which includes cashflow forecasting, is the best way to do this. As accountants specialising in helping small and growing businesses, we can point you in the right direction if you need some help with your plan.
Another, underlooked way to improve your profitability is to pay close attention to your taxes.
This is another speciality of ours, whether you’re operating as a limited company or another structure.
Get in touch for more information.