What is the Difference Between Profit and Cashflow?
To put it simply, profit is a story. It is merely a theoretical number. For example, you might say, ‘my business made $200,000 profit,’ yet you may not be able to buy me a cup of coffee with the profit your business made.
“Huh?” you say. Cashflow is factual. Operationally, there are three things that make up the difference between profit and cashflow in your business. Manage these three wisely as they have the power to make or break you:
- Stock on hand – more stock equals less cash. You could make a profit in your business for six months of $150k and think “wow this is great”, but have ZERO cash flow as you bought stock for the business to grow and/or take advantage of stock that was on sale. Be careful.
- Creditors – bills you owe. If you reduce your creditors in the month, you reduce you cashflow for the month, as you have effectively reduced your debt. If you start the month with $100,000 in creditors, and finish with $40,000, you would have effectively reduced your cashflow by $60,000 compared to your profit. $150,000 profit would turn into $90,000 cashflow on that alone.
- Debtors – money owed to you, that is, the money you loan to your customers. Yes, that’s right – you lend money to customers. It’s the opposite to the above point on creditors, in that if your debtors increase, your cashflow will decrease. Therefore, the better you are at managing receiving payment from your customers, then the more cash flow into the business.
If you don’t understand the correlation in your business between profit and cashflow, then work on the above three core items and you will soon get it.
The last point I’ll make in relation to debtors and lending money to your customers, is be very aware and understand you are in the business of lending. What do you know about your customer and how well they are managing their own cashflow, business or affairs?
This is a key point you need to consider and have a strategy around how you will minimise the risk to your business of not being paid.
Go down your debtors lists and see who you are lending money to. Ask yourself are they living the high life on your money. I have seen this happen many times.
This article was featured in The Newcastle Herald.