Business is booming, you are making more sales, getting more customers, and so you think “I should be making more money”. Yet, you discover that your profit doesn’t seem to be matching this level of success. Being cash flow-positive doesn’t necessarily translate into profitability and there are numerous reasons why they wouldn’t be aligned.
First, let’s address the difference between cash flow and profitability. Although there is a strong correlation between the two, they are not the same thing.
Cash flow refers to the net balance of cash that is flowing in and out of your business, at a point in time. Positive cash flow indicates more money flowing into the company, while negative cash flow shows more money flowing out.
With regard to profit, there are two main components, gross and net. Gross profit is your sales minus the cost of goods sold (COGS) or the cost of sales. Net profit is calculated as the balance remaining after all expenses have been deducted from your sales. In other words, your gross profit minus operating expenses equals net profit.
Their definitions sound similar but ultimately cash flow is describing the movement of money in a business, and tracks actual cash in hand. Whereas profit indicates the amount of money earned from sales after all expenses, the net earnings of a company.
Technically, profit is an accounting term that is affected by accrual accounting. An accounting method where your revenue and expenses are recorded when incurred, regardless of whether cash has been exchanged. That is why it is possible for your business to have a positive cash flow without making a profit, or be cash flow-negative while showing profitability. Revenue does not equal cash.
If your business is not seeing the profits you are expecting. Here, are some key themes to review that could provide some insight.
1. You are not pricing for profit. Get a clear picture of your business with accurate record-keeping. Then use this information to help you figure out your profit margins. Calculate your gross profit and gross profit margins. Then analyze if you are making enough revenue to achieve your profit goals. Also, analyzing profit per customer or understanding your least and most profitable products or services, will give you some visibility on where to improve your pricing strategy.
2. Your expenses are outpacing revenue. Businesses can fall into a cycle of increasing expenses based on stagnant revenue, which may not be collected until months after it has been recorded. A common oversight of a growing company is to increase its overhead too soon by hiring more staff, or getting a larger office space. Frankly, this should only happen once you have achieved your profit goals. Timing is a huge factor in profitability and cash flow.
3. Your expenses are too high. The most obvious consideration is to reduce your operating expenses, including the seemingly small costs. For example, consider reviewing your monthly subscriptions and ensure that they are still relevant to the business. Nowadays, software subscriptions are very popular and most businesses have an increasing number of monthly subscriptions to various applications. These can definitely add up without you noticing. Monitor these subscriptions to ensure they are still adding value to your business, and if not, it’s an easy way to cut costs.
Managing the cash flow and profitability of a growing business can be challenging. Once you are profitable, how you use your profit is critical to the sustainability of your business. No matter what stage you are in your business, there are several ways we can help you to achieve your profit goals. At Dharna CPA, we pride ourselves on providing our clients with the clarity they need to make key financial decisions. Understanding your financial position and implementing a solid strategy is the key to your success. Call us for a free consultation.