CASH FLOW AND PROFITS – IS ONE MORE IMPORTANT THAN THE OTHER?
Updated: Mar 18, 2021
In short, not exactly. As a business owner, identifying the correct financial metrics to track in order to gauge the health of your business is critical. Though it's tempting to place more emphasis on your business's profitability when evaluating its financial status, equal attention should be paid to cash flow. Having sufficient assets on paper doesn't always equate to a strong cash flow. If your business doesn't have sufficient cash flow, it won't have the cash it needs to satisfy all of its financial obligations.
The Importance of a Positive Cash Flow
When your business has a positive cash flow, it has more money coming in than it has going out. Even if your business is turning a healthy profit on paper, it's possible that your business will fail if you can't convert this profitability into a positive cash flow. This can lead to overdrawn bank accounts and late payments to your creditors and suppliers.
A strong positive cash flow is necessary for practically any business to cover their bills, but it's even more important for businesses that have a lot of seasonal business. You need to have healthy cash reserves to weather the periods when you have poorer cash flow.
Options for Improving Your Cash Flow
If your books indicate low cash flow, there are steps you can take now to begin to create more comfortable and consistent monthly cash flow.
Start by examining your accounts receivable turnover; your accounts receivable refers to the money that you're owed by customers. This is also where profitability and cash flow often have a disconnect. When you make a sale, this increases your profitability on paper. However, until you collect payment for the transaction, it won't improve your cash flow.
Improve your cash flow by turning over your accounts receivable more quickly. Decide if you should change your payment terms to give your customers an incentive to pay more quickly. The sooner you receive the money you're owed, the stronger your business's cash flow. One way to decrease the length of time it takes customers to pay you, is to build a strong relationship with them. Once you’re seen as a person vs. another company to which they owe money, you’ll see a greater priority placed on getting you paid.
You can also hasten your accounts receivable turnover by making it as convenient as possible for your customers to pay you. Consider expanding your accepted payment options so that credit cards and debit cards are accepted. A lockbox is a good alternative for customers who want to pay via check; they can drop the check into the box when it's convenient for them.
Offer to automatically deduct payments from your customers' accounts. This simplifies the payment process and means that there's one less bill they have to remember to manually pay.
Next, turn your attention to your inventory turnover. Generally, the faster you can sell your inventory, the better your cash position. Start by using sales reports to see what items are selling the best and which items are usually sold together. Then, market these items as must-have additions to customers who aren't purchasing them.
A final area to address in boosting your cash flow is the speed at which you pay your own accounts payable. While you shouldn't violate the terms of your payment agreement, you may want to take the full payment period before making your payment, especially when paying entities with little incentive to make early payments. This will allow you to hold onto your cash as long as possible.
Let the Experts Guide Your Financial Steps
Having experienced professionals analyze your financials takes stress off of you and will help you determine how to best proceed. Contact Fair, Anderson & Langerman at 702-870-799 to discuss your company’s options.