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Managing Your Business Cash Flow Cash Flow versus Profit

Cash flow is vastly different than profit. Cash flow is money which is coming into and flowing out of your business bank account or petty cash and may or may not contain profit monies. Conversely, profit is money remaining after a project has been paid for by a customer and all expenses are deducted by the business from that payment for the cost of the project. Profits will appear in your bank account before cash flow starts to happen.

Cash Flow and Profit Defined

According to Investopedia.com, cash flow is defined as the situation which occurs when “the company’s long-term cash inflows…exceed its long-term cash outflows”, while profit is defined as “a financial benefit that is realized when the amount of revenue gained from a business activity exceeds the expenses, costs and taxes needed to sustain the activity.”

Cash Flow Isn’t a Windfall

When cash flow comes into your business, especially before a job is completed, never view it as a windfall. Finance experts at the website InvestorWords.com’s definition of a windfall is when “money is received which is not expected and is not the result of something the recipient did”. Even though monies may seem to be a windfall, look more closely and you’ll see that seldom do funds meet the above definition of a true windfall. It can be easy to want to use non-windfall funds to upgrade or expand, but unless the money is actually profit, it will be needed to keep the company’s cash flow positive. If a project has not been completed and all expenses paid, you can find yourself spending money which will be needed for materials and other costs of doing business. Don’t set your business up for financial disaster in this way.

Don’t Inflate Your Operating Checking Account

When cash comes in prior to a job being performed, often in the form of a deposit on a contract or as monies paid to purchase materials to perform a job, place those funds in a special business banking account so that they are reserved only for those expenses associated with that specific project. Otherwise, your operating bank account balance can appear artificially inflated. This is also important should someone establish an agreement with your business, providing cash flow, and later cancel. Unless you keep the money in a separate bank account for refunds, based on your refund or cancellation policy, it can cause a hardship.

Reserve Cash Flow for Expenses

Just as the name implies, cash flow is easy to spend; it tends to want to continue flowing — right out of your hands! It is important to realize that this flow of money must cover daily expenses, payroll, yearly expenses like taxes, and emergency expenses as well as upgrades and expansion. The money flowing in and out has no relationship to the amount of profit you’re earning, and that has to stay in the front of your mind as you manage business finances.

Spend Profit Only

After your business has completed a project and all associated expenses have been paid in full, you can determine the exact amount of profit which was earned from that project. The Marketing Guy states on his blog at TheMarketingGuy.files.wordpress.com that “some of us have forgotten how to calculate profit…The first business you started was probably a lemonade stand and nothing has really changed since that.” Simple worksheets can calculate the cost of projects, like material, labor, advertising, and other direct costs, subtract it from the income from the project, and will tell you what profit it actually made. That is the only amount which can be spent for anything other than the cost of production. If you apply cash to other needs, you will almost certainly sabotage the project to which the cash should have been applied.

Invest and Spent Profit Wisely

Once you know your profit amounts, you can choose were to apply those funds. Wise investments to help your company provide a cushion during tough economic times or slow business periods are a wise use of some of your profit. Reinvesting into your business can be smart, too if you need upgraded equipment or an expansion in advertising or staffing. If you have enough profit, investing in sound, well-advised investments such as stocks, bonds, annuities, and other securities can be wise but you should seek the advice of a skilled expert in investments before sinking your profits into these financial vehicles. Above all, keep a prudent reserve of funds from your profits for emergency expenses.