This question has been asked by business owners countless times over the years. If you are not an accountant it is an understandable question to ask especially when business success is measured in terms of operating profit.
If your business is profitable you assume that you are able to pay all your bills. However, this is not always the case in small business. A successful business will be profitable and create positive cash flow for the owners and their desired lifestyle.
Cash flow and profit
Cash flow and profit are both vital for a successful business. Your business cannot be successful if you only have one of these important ingredients. For example, it is possible to go broke making a profit if you don’t have cash flow.
Cash pays the bills not profit. Poor cash flow is continually cited as one of the main reasons for small business failure. Similarly, cash flow without profit is not sustainable in the long term. A business that is not profitable must be obtaining its cash from other sources such as overdraft or loans to keep the business going.
Are you measuring cash flow?
If cash flow is vital for a successful business why do many businesses only measure success in terms of operating profit? I don’t believe operating profit should be the sole measure for business success. Cash flow and operating profit should both be used to determine the success of a business.
One method to measure the cash flow in your business is to calculate the Operating Cash Flow. The Operating Cash Flow is the actual cash made by the business. It is calculated in a similar way as operating profit but it only includes cash received and cash payments.
By analysing your Operating Cash Flow as well as a Profit and Loss Statement you will get a clearer picture of how your business is being managed. Using both measures gives your analysis depth as it shows how effective you are managing your stock, debtors and creditors as well as your income against expenses. It will also help you understand how your operating cash is being used.
You can’t manage if you aren’t measuring
Cash flow is critical not only for your small business but also for the advancement of your lifestyle. However, very few small businesses measure their cash flow. They rely solely on measuring operating profit to determine their success.
If you start measuring your business’s cash flow instinctively you will start managing your cash flow. Once you see the impact of slow paying debtors or obsolete stock is having on your bank account you will be motivated to correct the situation. This will lead to a more successful business and better lifestyle.
Below is an example Operating Cash Flow Statement. As you can see it only takes two minutes to complete. However, the information can be invaluable to a business.
In this example, the business made a profit of $43,400 however it only made a cash profit of $7,800. In this example, debtors and stock are the main contributors to a lower cash profit.
If you want help making sense of your numbers and simple strategies to manage your business then call me on 0434 972438 or use the Contact page.