One of the most important things when running a small to medium business (SME) is understanding your finances. Cash flow, profit, and revenue are all vital for long-term success, but knowing their differences can help you focus on what is actually the most important.
As a business owner or entrepreneur, you might (understandably) be attracted to big revenue and profit numbers. However, cash flow is what truly keeps everything going. Let’s look at the differences between revenue, profit, and cash flow to give you a clearer idea of why cash is the reality of businesses.
This is the gross income of your business before the expenses are deducted. For example, you can generate $10m in revenue for your business but still have debt with no profit. That’s because revenue can include money earned from sales, interests, investments, or the money that is yet to be received by your business. The large number at the top of your income statements may look good on paper, but it won’t give you the final number you should be focussing on.
Profit is the amount that remains in your business when costs are deducted from revenue earned. To make a profit, your revenue must be higher than your expenses. It is far more insightful than revenue when it comes to knowing your business health, but it’s not something you can use to accurately predict your actual cash flow, as profit is a P&L line item and many things that affect your cash flow are not in the P&L due to accrual accounting; prepaid expenses; annual expenses paid upfront but accounted for monthly in the P&L; and the movement in cash from one month to the next, otherwise known as working capital movements.
Cash flow tracks the actual money in hand or the money that goes into and out of your business at any given time. Cash flow positive is the cash that is deposited into your bank account net of all expenses, or you received as cash that can be counted as an inflow in excess of any outflows. Meanwhile, cash flow negative is when the amount that’s going out of the business is greater than the money coming in. Obviously we want our SMEs to be in a positive cash-flow position as much as possible.
Why You Should Focus on Cash Flow
Cash flow provides a better sense of the financial situation of a business. Profit and revenue can’t give you a complete snapshot of how your SME is doing financially. This is because the two don’t tell you the ongoing inflows and outflows of cash, especially during the daily or monthly reports of your business’ financial well-being.
With cash, you can support your operating expenses and generate new sales. Regardless of profits, if you don’t have money on hand to meet your commitments, it may lead to ceasing your operations. Cash flow also enables you to settle debts, return cash to shareholders, pay expenses, and provide a buffer in case of a financial crisis.
“When you’re applying for financial assistance, lenders will look at your cash flow statements.”
When you’re applying for financial assistance, lenders will look at your cash flow statements since they expect regular repayments for the financing they will provide to your business. Your cash flow statement determines whether you can afford to repay them in a timely manner or not. If you have a stable cash flow, lenders may consider your business, and you will save yourself from the unnecessary stress of paying late fees.
Cash flow has critical importance in your overall operation. If you have cash, you can keep your company functional. Sufficient cash is essential to meet your short-term or long-term financial obligations. In the end, proper management of your expenses and consistent tracking of your inflow and outflow can help your business remain profitable.
How to Maximise Your Cash Flow
It’s more important than ever to review and take stock of your SMEs cash flow position and outlook. According to NAB’s recently released ‘Supporting Economic Recovery’ study, SME’s are increasingly stressed about late payments and therefore, their cash flow. NAB’s research found that 53% of their invoices are not being paid on time. It isn’t easy to make financial decisions when the majority of your expected incoming cash flow isn’t received when expected.
While there is no magical solution to this problem, there are two solutions that may help improve your ability to enhance your SME’s cash flow:
Use Electronic Invoicing
E-invoicing is the best way to send invoices and receive payments from your customers. E-invoicing is a system that allows you to automate the exchange of invoices between your customer’s accounting system and your own. This makes it easier for your business to be paid on time as reminders are sent, payments are made online, and messy physical paperwork is eliminated, taking manual errors with it.
Consider Invoice Finance
Invoice finance is an excellent tool to unlock cash from your unpaid invoices. Invoice finance providers will pay you up to 90% of your verified outstanding invoice value upfront. When your customer pays and the funds are received by your invoice finance provider, they’ll remit the remaining 10% minus a small fee to compensate for early funding. Your business can use this cash instantly to pay your bills, secure new suppliers or invest in growth opportunities.
Take the time to understand your SMEs financial position and the impact cash flow has on your ability to operate and thrive. Don’t let poor cash flow hold your business back, improve your growth prospects by unlocking tomorrow’s cash flow today with TIM Finance.