What is Cash Flow?
Cash flow is the inflow and outflow of money from a business. It is necessary for daily operations, taxes, purchasing inventory, and paying employees and operating costs. Cash flow is more important than profit for a small business, because understanding a company’s cash situation is crucial to making sound business decisions.
Why is it Important?
There are several specific reasons why cash flow is more important than profit. First, cash flow statements provide a more straightforward report of the cash available. In other words, a company can appear profitable “on paper” but not have enough actual cash to replenish its inventory or pay its immediate operating expenses such as lease and utilities. Without cash to purchase inventory or pay expenses, a business will fail. As Hatten (2014) states, “Many businesses show considerable profit but have problems paying their bills—meaning that they have a cash flow problem”.
Second, profit reports are based on sales income. What this means is that the recorded revenue is often greater than the amount of actual cash received from sales. This speaks directly the question: “If your income statement shows a profit at the end of the month, how can anything be more important than that?” In actuality the sales may be on credit. When that is the case, the collection period on accounts receivable can last some number of months. This means, therefore, that the company needs to have enough cash on hand to continue its operations for the entire collection period.
Third, lenders rely on a company’s current and projected cash flows to determine whether it will be able to afford the additional debt. Obtaining loans is thus dependent upon a company’s cash flows, which is another reason for their importance.
In sum, maintaining a comprehensive understanding of one’s cash flow picture is often more important than appearing to demonstrate a profit.
And if we can help you boost your cash flow, please contact us today.
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