Cash versus profit

I once heard a business owner remark: “My accountant tells me we’re profitable, but we never seem to have enough cash.”

Make no mistake both profit and money are important. Money 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. Positive cash flow can be best described as the lifeblood of a business, not profit. It is cash that pays the wages each week. Cash pays 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.

There is a direct connection between profit and cash. 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 %. The higher this margin is above the businesses break even Profit Margin the greater the benefit will be seen in a more positive cash flow. Having established the key measure of how much profit is required to break even 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 as EBITDA.

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

The importance of turning profits in cash cannot be emphasized 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 money is not collected. The credit terms that a business grants to its customers  should also be reviewed monthly. With this you should also monitor the level of debtors outstanding outside of the agreed terms. Slippage in the average Debtor days means that cash owed to the business is not being collected as quickly as  it was. This would indicate that some sort of action should be taken.

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