April 29, 2016

The difference between cash flow and profitability

The difference bewtween cash flow and profitability

Cash flow and profitability - two of the accountancy industry’s favourite phrases, and words you’ll find in no short supply on the pages of our blog. For business owners though, it’s really important to understand the difference between the two.

Profitability means making sure your business consistently pulls in more money than it spends, covering all your costs, including wages, taxes and your own drawings on an ongoing basis.

Cash flow isnt so much about covering all your costs, its about making sure theres enough money in the business to pay the next bill or expense when it arises.

An unprofitable business will inevitably face cash-flow issues over time, but its crucial to realise that even a profitable business could run into cash-flow problems too. And when that happens, it usually means youre not getting paid quickly enough by your clientsor youre paying your suppliers too quickly.

Getting money into your business faster

If your suppliers or contractors issue invoices with tight payment demands, or even demand payment up front, money goes out of your business before youve had chance to get any in.

All it takes then is for your clients to drag their heels paying you your dues, and youre left with a cash flow problem akin to a financial black hole.

Thankfully, for profitable businesses at least, these issues can be fairly simple to resolve. Revisit your invoicing processes, and look at your payment terms. Are you showing your clients too much leniency with your terms? Do you issue invoice reminders to hurry things along when they dont pay? Could you start taking card payments to get money in faster?

Similarly, review your arrangements with your suppliers. If you have a close working relationship, speak to them and ask for better credit terms.

If thats a no go, you could look to free credit solutions (paying bills on an interest-free credit card for example) to keep your money in the bank that little bit longer.

What if profitability is the problem?

If your business isnt profitable yet, then getting money in quicker, or keeping it in the bank longer, wont be enough to stem the tide.

When profitability is the problem, you need instead to focus on either bringing in more sales or cutting down your expenses to keep yourself in the black. Help is at hand here too, and indeed we have plenty of articles on this blog which may be of use to you in your quest for profitability.

Moving to a value-based pricing model could help. Paying less tax each year would certainly help. And of course, gaining a deeper understanding of your figures to help you identify cost-savings is crucial - in which case, management accounts might be worth investigating.

If youd like to discuss any of these cash flow or profitability issues with us, please just give us a call on 0121 667 3882

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You may find these blogs of interest too:

VAT for business explained

Budget April 2016 tax changes

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