Most small business owners know they need to make a profit to keep the doors open. But cash flow is also crucial to keep your business running. When you understand cash flow vs. profits, you can make smarter decisions about your company’s financial health.
So, is cash flow the same as profit? And is one more important than the other? It depends on your business and circumstances. Let’s find out what each can mean for your business.
What is cash flow?
Cash flow is what you’re bringing in and spending. It’s the movement of money in and out of a business and the lifeblood of any company. Cash flow management is one of the most important aspects of running a successful business.
A positive cash flow indicates you have more money coming in than going out and generally means your business is doing well. Without the right balance of cash going in and out of your company, you can struggle to pay expenses and employees and build up a financial buffer to cover future challenges.
What is profit?
Profit is the amount of money left over after paying the company’s expenses. When you add up the money you receive from sales or services and subtract what you spent to produce those goods or services, you end up with profits.
Profits are typically what small business accounting is focused on. It makes sense — without profits, your business may not be open for very long. It can motivate employees to work hard and spur growth to increase production or enter new markets.
Cash flow vs. profits: What’s more important?
Why is cash flow important? The answer isn’t as straightforward as you might think. It depends on the type of business you are running.
Small businesses, especially new ones, usually need more focus on cash flow. If you are an established company with a big name and a lot of customers, then profits might be more important for your business.
For example, consider these scenarios:
You’re starting a business
Cash flow vs. profit is most difficult when you’re in the early stages of starting a business. You might have many expenses and not many sales. Even if you have customers paying you, that may not be enough to float your business over the long-term.
In this case, cash flow is likely the most important. You need a healthy amount of funds coming in and out to cover employees, contractors, supplies and equipment to get your business up and running. A temporary line of credit, business loan, credit card or money from savings can help you cover cash flow gaps.
You’re struggling to pay employees
Your business might be seeing huge success with profits rising quickly. But if your customers aren’t paying on time — if they’re taking 30, 60 or 90 days to pay their invoices, your cash flow can dry up.
This is another scenario where cash flow can trump profits. You might not have enough money coming into the business to cover payroll. Without the cash flow moving money into your bank account, you can run short on funds.
Your business profits are low
Cash flow is important, but so are profits. If your company isn’t making money, shift your focus to building profitability. Here’s why: Low profits can impact cash flow.
For example, suppose your profits are low because a competitor came onto the scene and attracted some of your customers. Or a global pandemic slows down foot traffic to your location. When this happens, you may dip into your cash reserves to cover expenses like rent, utilities, raw goods and employee and contractor wages.
When profits are down, you can end up with more money going out than in. That’s why profits are crucial — when they’re up, a smart business owner sets some aside for a rainy day.
You run a seasonal business
Profits are essential for a seasonal business, but cash flow is more important. Without proper cash flow management, you might not have the funds to cover expenses during the off-season.
You might have a huge influx of cash during certain times of the year if you run a holiday or summer business. For example, a lawn care company can earn large profits during spring and summer, but money can be tight during the winter months. Managing seasonal cash flow is tricky, but it’s possible if you’re diligent.
You want to expand your business
When it comes to a company’s success, profitability and growth go hand in hand. That’s because profits are fundamental for future business growth. If you want to open a new location, enter a new market or add products or services, you must have a healthy profit margin.
A company’s profitability is also critical to securing funding from banks and attracting investors to fund operations and grow the business. Banks and investors may not think your business is worth the risk if profits don’t meet the mark.
How NEXT helps small businesses thrive with business insurance
Profits and cash flow are vital metrics in any small business. Whether you run a business in lawn care, Amazon e-commerce, construction or fitness, you must have systems in place to monitor and forecast both.
Another key part of running a small business is having business insurance. A small business insurance policy can protect you and your company from the costs associated with property damage and liability claims.
Small companies can suffer costly damages and legal claims without business insurance. And paying out-of-pocket can impact your profits and cash flow. Rather than leaving it to chance, get a comprehensive small business insurance policy from NEXT Insurance.
Getting a certificate of insurance from NEXT takes about 10 minutes, and everything is streamlined and completely online.