Money management & mastery

Writing my penultimate chapter in the new book 'Money'. Here's a small part of the 'Money management & mastery' chaper on 'cash flow vs. profit' 

Cash flow vs. profit

Cash flow and profit are obviously not the same. Many start ups and grown up businesses act like they are or don’t know the difference, and that’s dangerous for wealth building. 

Cash flow is the net amount of cash and cash-equivalents moving in and out of a business. It can be positive or negative. Cash flow are liquid assets that enables a company or person to settle debts, reinvest in its business, return money to shareholders, pay expenses and provide a buffer against future financial challenges, and includes retained profits not yet drawn down. Net cash flow includes accounts receivable and other items for which payment has not yet been received. Cash flow benchmarks the quality of a company's income and how liquid it is, which can indicate whether the company is solvent.

Profit is how much money a business is making once all expenses have been deducted. These expenses can be fixed and/or variable costs. Fixed costs remain the same for the short term such as rent, fixed salaries, insurances and depreciation. Variable costs change month to month such as cost of sales, heating and marketing spend. Even a profitable business can fail if the business has an unbalanced cash flow.

A business or person may be profitable on paper, but have inadequate cash to pay immediate expenses. This is when a company can still be profitable yet becomes insolvent. This can happen because most businesses allow a grace period between when goods or services are delivered and when they are paid. Some big, immediate and unexpected expenses, legal battles, debtors going bust or not paying, too much cash held in stock that doesn’t sell and other unplanned cash events can result in a company running out of cash. 

Credit & Business Finance identifies poor cash flow management as the main reason small businesses fail. Ensure you set up a cash flow forecast that will indicate where and when cash is coming in and when cash needs to be paid out. I receive a weekly statement from produced from my businesses with a cash in bank figure, creditors, debtors and retained profit amounts. There is a gross actual current cash in bank figure and a net after reconciliations amount. We don’t hold much stock but if we did I might request that be included. If we were 10x the size, held a lot of stock and had lower margins I might request this figure daily. This can be compared to previous years as a measure of progress and stability. 

Evaluate payment terms to ensure there is not too much grace period or time lag between delivery and payment. Bringing payment forward can improve your cash flow. Having better systems, ensuring customers are paying on time and are good quality, using collections if necessary, and evaluating the profitability of customers and products will all improve your cash position. Target cash flows as well as profits and watch your cash closely. For long term products and delivery, monitor closely profitability because you good have good cash flow with big upfront fees that could be creating a loss down the line.

You could have good liquidity upfront but insolvency down the line. Driving turnover that doesn’t have a good profit margin can hide or delay solvency issues so in this regard not all money is profit.

Any comments or questions, happy to answer below.

Rob Moore