Why Cash Matters More than Profit
When it comes to building a successful business, there is one element that business leaders often focus on which is profit. However, while profit is a good measurement, it doesn’t mean that's the most important aspect of the financial performance of a business. Instead, cash might be more important.
In this article, we will be looking at why cash matters more than profit.
Difference Between Cash flow and Profit
One of the big concepts to grasp as a business leader is the difference between cash flow and profit. Cash flow is the amount of money coming in and out of the business. Whereas profit is the figure that is the difference between revenue and sales after all transactions are completed.
The difference is very subtle, but cash flow looks at the books in an almost real-time aspect.
Whereas profit takes a look at the finances from a different perspective. They will often include cash that has not entered the business’ financial ecosystem yet.
Cash flow can also include investment elements, such as business loans and investment put into the business, which is not included within the profit and loss account.
Why is Cash Flow Better than Profit?
There are several reasons why cash flow looks better than profit. For one, without cash in reserves, there are no funds to pay for business operations. Businesses that don’t have cash, can’t buy new supplies, pay employees, pay freelancers or even pay for marketing.
Being unable to pay for basic business operations will lead to the business failing.
Another factor is that it is hard to get sales when the business is young. You won’t have the reputation or the connections to ensure a steady stream of leads and sales. Therefore, sales in the first few months can be challenging. Therefore, you need to have a lot of reserves to ride out the first few months, you might also need to reduce your living expenses for the first few months or years.
One of the main reasons why businesses fail is because of their lack of cash flow. They can sometimes have the sales coming through, but because it can take time for transactions to complete, or for customers to make a payment, business owners often need to dip into reserves before they start seeing their income.
What is the Average Small Business Profit Margin?
Net profit margins can vary by industry and business model. Some organizations concentrate on a high-volume, low-profit margin tactic whereas others prefer a low-volume, high-profit margin tactic.
However, on average, the Corporate Finance Institute states that the average profit margin for a business is about 10%. Those that are performing at 20% or more, are considered to be very healthy. Those that can’t achieve higher than 5% are considered very low or poor.
How to Increase Profits
There are several ways that you can improve profits, which include some of the following elements.
1. Increase Prices
Increasing prices might mean you lose some customers, but generally, a small increase will have a minimal impact on customer retention, but improve profits and cash flow within the business.
2. Customer Retention
Customer retention is one of the best ways to improve the profitability of a business. Just a 5% increase in customer retention can increase profits by up to 95%. There are numerous options for increasing retention.
3. Lower Costs
Lowering costs is an effective option in some cases, but you have to be sure you’re not going to compromise on the quality. Try negotiating with suppliers, especially creditors who might be able to offer better rates.
Final Word: Why Cash Matters More than Profit
Cash is one of the most important factors for the success of the business. Without a good cash flow, business fortunes can be much worse off and might even force the business to fold, even when the business is making a profit.