Build a profitable business- the baby steps part 16

A lot of people believe that profits are more important than cash flow.

That is simply not true. They both play a vital role, albeit poor cash flow will often result in a more critical business crisis.

Lack of profit will kill a business, but it will be a slow painful process. More importantly the alert and skilled entrepreneur will in most cases have enough time to do something about it. Also, a nice profit doesn´t ncessesarily mean that the business will enjoy a good cash flow. Without a solid cash flow a business can find itself in trouble quickly. A poor cash flow is fatal, as it is required for the business to operate efficiently. Cash flow is what pays for rent, wages, bills and all those unexpected expenses that are bound to come your way. And it has to be cash flow that is being generated by the operations of the business. Enterprises that find themselves in trouble often find themselves trying to cut corners by selling inventory or company assets. In some cases items are sold and then leased from the buyer. While this is an effective way to get hold of some fast cash, it is often not a viable longer-term option.

What you are looking for really is a high pace (and rate) of conversion. What this means is that you want the profits that the business is generating to be transformed into cash flow as quickly and automatically as possible. If you can achieve this, half the battle has already been won. That is why cash flow is at least as important as profits. In fact, we like to think of it as THE most important aspect of keeping score as you are starting up. And that´s why you should always keep a close tab of your cash flow. Profits keep the shareholders and the owners of the company happy, but it is the cash flow that ultimately must keep the ship afloat.

Profits is the difference between the income and expenses of your business. Minus some accounting magic such as depreciation or asset purchases. Cash flow on the other hand is just what it claims to be. It is an accurate number representing the flow of money into and out of your enterprise, either through daily business operations, financing activities and investing activities. Most companies starting out pay close attention to cash flow without even realizing it. By making sure you get payed as soon as possible, and at the same time delaying your own payments as much as possible you are improving your cash flow. By keeping costs low and focusing all your energy on selling, you are improving your cash flow (and most probably your profits as well). If you are new to the life of the entrepreneur the advice contained here is worth a lot more to you than you might imagine.

When I started out I instinctively watched my cash flow, and I did so with a vengeance. In all honesty, the main reason I did that was that I simply didn´t understand enough accounting to be “fluent” in that language. Cash flow I understood. It was all about the money coming in, and the money coming out. The difference gave me a good idea of how we were doing. There were many times where my books didn´t agree with those of our accountant. The reason for this was a natural one; he presented our company´s economicla health in terms of profits while my spread sheet was all about the cash flow. By comparing my numbers to his, I soon learned the differencies between cash flow and profit, and how a profit statement could indeed at times be quite misleading as to what state the economics of the company was in. Today I am fluent in both of them, and so should you be. But if you are starting out and you don´t know a lot of keeping books, my recommendation is to keep a tidy cash flow spread sheat and update it on a continuos basis. By doing this you will dare you paying for that service?evelop a sixth sense regarding your enterprise. Pretty soon you will know all the numbers by heart. The costs, the revenues, the loans. You will remember every single detail, and that will be a great asset to you and it will also save you lots of time over the years.

Profits provide an electrocardiogram of your business. It tells you how your business is supposed to be doing. Cash flow is the actual heartbeat of your business. It represents the true state of your business. If you only manage to get your cash flow in shape, you can always focus on improving the profitability later on. Doing it in the reversed order, i e focusing on profits first and then cash flow, may not always be a possibility. Without cash flow there just may not be a business to attend to whatsoever.

Profit is nothing more than a theoretical assesment of how you are doing. Profits are the language of the accountant and the tax authorities. Cash flow is the language of the entrepreneur (and his lenders). Profits are a map. Cash flow is the actual landscape. To put it another way: a business with a positive cash flow can never ever go broke. On the other hand, a business with a positive can and will at times go broke.

Lack of profit seldom leads to the termination of a company. More often than not, it is poor cash flow that makes the “game over” sign appear. Profits are important. Cash flow is omnipotent. We had the good fortune to learn that lesson early on in our entreprenurial life. So should you…