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Why Profits and Cash Flow Are Both Critical to Your Business’ Success

It’s hard to stay in business when you're out of cash. This post outlines the difference between profits & cash flow.

If asked what is the most important key to business success, many owners will answer, “Earning a profit.” And yes, profitability is certainly critical to running a successful business. After all, why own a business if your goal isn’t to make money?

 

However, there is another business success factor that is just as important as profitability, if not more so: ensuring strong cash flow. Poor cash flow is one of the leading causes of business failure — because while companies can often ride out short-term periods of unprofitability, it’s much harder to stay in business when you run out of cash.

 

Cash Flow vs. Profits

First, though, it’s important to understand the difference between profits and cash flow. Doing so requires understanding how a typical business cash flow cycle works, says Delpha Bartley-Jones, Vice President and Senior Relationship Manager, Small Business Banking, with Cadence Bank.

 

The cash flow cycle describes the movement of cash through a business as products are made and sold and revenue is collected. First, cash is paid out for raw materials, equipment and overhead that is used to manufacture products or deliver services. Once products and services are sold, an invoice is issued to the customer and the business must collect the money it is owed, or its accounts receivable. At this point, cash flows back into the business and the cycle begins again.

 

It’s important to note the cash flow cycle has nothing to do with profitability. A business can show a healthy profit on its profit & loss statement based on its ability to sell high-margin products and services. But if the company is not collecting and depositing its accounts receivable in a timely manner, it won’t be able to meet its day-to-day operating expenses. In this scenario, the company could run out of cash and fail before it has the opportunity to realize those healthy profits on the P&L.

 

Tips to Improve Cash Flow

“Gauging your cash flow and knowing your company’s cash position at all times is critical,” says Bartley-Jones. “Otherwise, you could reach the end of the month without enough liquid cash to pay the mortgage or rent, pay suppliers or meet payroll.” She offers the following four tips for improving your company’s cash flow:

  1. Carefully monitor your accounts receivable. The best way to do this is to create an A/R aging report. This will show you at a glance which customers’ payments are current, which ones are past due, how late past-due payments are, and how much these customers owe. “This way, you can see where to concentrate your collections efforts,” says Bartley-Jones.
  2. Make receivables collections a high priority. Be firm in enforcing the payment terms you’ve negotiated with suppliers. “Don’t let past-due payments drag out for weeks after the due date,” says Bartley-Jones. “These late payments can cause a serious cash flow lag.”
  3. Strategically manage your accounts payable. This is the flip side of receivables management. Your goal should be to set up your accounts payable system so that invoices are paid on the due date, not before or after. And negotiate as favorable payment terms with your vendors and suppliers as you can.
  4. Use cash management services from your bank. Bartley-Jones stresses that banks provide a wide range of cash management services that can help you improve your business’s cash flow. With remote deposit capture and lockbox, your checks can be deposited into your account faster, thus improving the availability of funds.

 

“ACH payments also improve funds availability and cash flow by depositing receivables into your account electronically,” Bartley-Jones adds. “This eliminates check float and delays caused when checks sit on your bookkeeper’s desk for days (or longer) until they get deposited.”

Please contact your Cadence Bank representative to learn more about ways to improve your business’s cash flow, as well as these and other cash management services that can help.



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