Why Cash Flow Is More Important Than Profit

Most people who start businesses often set goals focusing on generating profit.  They thinking about margins, absolute numbers, and the money they can make.  However, while a healthy profit margin is essential for long term business sustainability, cash flow is really king when it comes to covering costs and operating expenses.

Why is Cash Flow Important?

Many expenses that occur in a business are not payable right when the transaction takes place. This could be the purchase of inventory on credit terms or interest repayments on loans. Also the money on sales are not received if the goods or services were sold on a credit basis. This can create a scenario where you need to meet liabilities, be it a supplier or a bank, while at the same time waiting to receive the cash from receivables. In this situation the company could be turning a profit but is struggling in terms of cash flow.

The Consequences of Poor Cash Flow Management

If the above situation occurs to you, you can be liable to facing further charges.  With creditors given the right to add interest onto payments owed or banks demanding sale of assets used as collateral to loans even if they are integral to the business, poor cash flow management could be very costly to your business. In rare cases you could even face a liquidation notice forcing the closure of the business and all assets sold to repay the money that is owed. It is for these reasons it is important to pay your debts on time by making sure you have a healthy cash flow.

How to Obtain a Healthy Cash Flow

To ensure healthy cash flow throughout the business there are a variety of methods that can be used. Firstly it is vital to make cash flow forecasts, which will give you an estimate when money is coming in, and when money is going out. Through this you will be able to identify when there will be a lack of cash and give you a chance to rectify the issue.

Secondly, once an issue is identified you can take steps to meet the liabilities. You may consider offering an early settlement discount to receivables to ensure cash enters the business sooner, or changing credit terms to a shorter amount of time for those who owe you money, and longer amount of time for those you owe money too. However this will only work if you have a strong relationship with the other party.

A third way to keep a healthy cash flow is to sell your current receivables to a factoring company or sell your future receivables to a merchant advance company.  For a small fee, factoring companies purchase your receivables, giving you most of the cash upfront and paying you the rest after the collection.  The merchant advance company purchases your future receivables at a discount giving you the cushion you might need for healthy cash flow.  If possible, keeping a cash reserve in the event of unforeseen circumstances is always a good idea.  

While both cash flow and profit are extremely important, for day to day operations cash flow is vital to any successful company.  Focusing on profit and neglecting cash flow can result in a failing business.