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Profit versus cash

Posted on 15/12/2015, 14:56

“Cash is King”

Turnover is vanity, Profit is sanity and Cash is reality…

These are all familiar quotations or sayings that you may have come across whether you are starting a new business or have an existing business. The latter saying is not attributed to anyone that I can trace but it has been called the “Bankers Mantra”

So why is cash so important to bankers, versus profit?

Make no mistake both profit and cash are important and cash is generally not generated by a business unless it is profitable. There can be exceptions, such as the sale of fixed assets but for this article I am considering the trading activities of a business only.

I believe that Positive Cashflow can be best described as  the lifeblood of a business, not profit as it is cash that pays the wages each week, the monthly salaries and enables new employees to be recruited or loans repaid and shareholders dividends to be paid. Profits cannot do any of these things.

However there is a direct connection between profit and Cash and both should be monitored carefully on a regular basis. Cash perhaps daily or at least weekly, depending on your business. It is easier these days with the development of bank online apps.

Profit should be reviewed at least monthly and through the use of a management accounts package, which all business owners should use, for their benefit not just for your accountant.

Profits, particularly Gross Profit should be monitored through the Gross Profit Margin % and the higher this margin is above the businesses Breakeven Profit Margin the greater the benefit will be seen in a more positive cashflow.

Having established the key measure of how much profit is required to breakeven you are able to build a plan around the growth of the Gross Profit margin, which in turn should directly benefit the “bottom line” of Net Profit, or perhaps you may prefer to measure the profit at EBITDA level.

However a healthy or strong retained profit does not necessarily mean a strong business.

The importance of turning profits in cash cannot be emphasised enough.

Turnover/Sales/Fee Income etc are all calculated thorough the generation of invoices but it is of no use to a business or the shareholders if the cash due to them from, hopefully increased sales, is not collected.

Apart from the monitoring of the Gross and Net profit margins the credit terms that a business grants to its customers or clients should also be reviewed at least monthly along with the level of debtors outstanding outside of the agreed terms. Slippage in the average Debtor days means that monies owed to the business are not being collected as quickly as previously so action may be required.

Another common phrase or saying and a sad reality is that “Businesses fail not through lack of profit but through lack of cash”

In short; monitor and seek to improve profit at the same time focusing on making sure the cash is collected in a timely way.

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