Cash Flow and Profits: We Feel Cash Flow, We Don’t Feel Profits

All business owners know that cash is king and cash flow is the life blood of any business. Nevertheless as great as having a cash flow is, it does not always translate into profits. Profits are an elusive thing especially for those business owners who operate much of their business from their “gut”. The feeling that one gets from having a cash flow tends to give the illusion that one is making a profit and the larger the flow the bigger the illusion.

The reality is that while you may have a large volume of cash coming in, it is also easy to have a larger amount coming out. We tend to notice this when the cash flow slows down or when we can’t seem to figure out why were having problems keeping up with bills although money is constantly coming in. The one thing that business owners need to understand is that you don’t feel profits.

Think about it this way, the ability to view your profit is like taking a snapshot of your cash flow at a particular instance to check how much money is coming in verses how much is being expensed out. There are many reports that can produce this snapshot(Profit and Loss Statement {P&L}, Income Statement, Statement of Cash Flows ) in many accounting software programs in the market provided that the firm has solid accounting practices. Good operational and audit control practices also help in the monitoring of profits through solid project management protocol by ensuring that projects or production lines stay on time and within budget.

Smart spending during times of high cash volume is essential. It is best to be conservative and more guarded when cash is plentiful. Most business fail during times of growth because of a lack of understanding of how and where to allocate resources as well as the lack of implementing the proper infrastructure to increase supply to meet demand.

Another pitfall of high cash flow is capital improvements or taking on new debt to purchase or upgrade new equipment, software, etc. because we want to remain or gain a competitive edge within our industries through technology. As business owners we tend to lose sight of the fact that everything in business is cyclical and cash flow may not stay high forever. Business owners tend to be less risk adverse during the times of high cash volume and bullish when it comes to maintaining that level of cash flow.

Taking on new debt with higher interest rates or unsecured loans with the mindset that the liability can be quickly paid off or simply paid off the loan in one payment if needed. It hardly ever works that way, and often times we get side tracked by overhead, i.e. another purchase, equipment failure, a project falls behind schedule, or a lawsuit occurs.

While it is always better to use someone else’s cash to finance things within your business, however if you find too many loans sit on the books then your profit margin will be eaten up by your loans interest rates. So if your highly leveraged (took out too much debt) you can be making a profit from every job or unit, have outstanding collection policy, and paying off all current expenses and it still won’t matter because you will have spent all of your future profits away in interest from debt financing.

So what to do with excess cash? Do we let it just sit there…well no, the answer to that is complex and depends a lot on your individual business situation. However here are a few examples of what you can do if you’re in the position of having a large cash flow:

The first thing I would say for any business or organization is to understand your costs so that you can provide yourself with an accurate picture to see if you are indeed making a profit. In this case if you don’t already have one, I would recommend hiring a bookkeeper and/or CPA( staff [W2] or independent contractor [1099] ) to make sure that your expenses are going into the correct account(this will also help with taxes at the end of the year).

The second thing I would recommend is take a look at your debt structure and see what current debts you already have and make a point to pay off the loans with the highest interest rate (if the life of the loan is too long or outstanding balance is too high then look into refinancing or consolidation for a better interest rate), this will allow you to raise your overall profit margin by reducing overhead.

Third would be to invest in either stock or bond markets with any residual cash. I will write more about the pros and cons of investing in the financial markets and how they can help offset interest rates of loans, defer/lower taxes on profits through capital gains tax, and increase profits through dividends.

While cash flow will keep the doors open and business running smoothly. Cash is not the only way that a business creates wealth. A companies worth is more than the cash it can generate in profits from revenues. Understanding your brand as a company and the impact that has on the customer is also a vital component to a company’s wealth.

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9 Comments

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