12 November 2019
Expansion & Improvement
The difference between net profit and cashflow can be explained in fairly simple terms. Net profit is work you’ve invoiced, minus expenses. Cashflow is the movement of physical cash in and out of your business.
Making a profit is probably the key goal of any owner-manager. But if you’re only focused on income and profit, you’re not seeing the bigger picture of what’s going on financially in your business – and that can lead to problems with debt, cashflow and working capital.
If you can understand the key differences between profit and cashflow, you’ll have better control over your money, and better control over the future of your business.
Daniel Rose, Partner at Haines Watts Essex, explains how to get to grips with profit vs cashflow, and how this helps you to make better business decisions.
What’s the difference between net profit and cashflow?
As an owner-manager, you probably spend a large percentage of the working week worrying about how much money is coming in to your business. But do you know the key differences between your company’s profits and its cashflow position?
To begin with, let’s define those two terms:
Net profit is the work you’ve done minus expenses – from an accounting and financial perspective, net profit is what you’ve invoiced out and what (you hope) you’ll eventually be paid, less any cost of sale and overheads.
Cashflow is what’s actually come in as cash – cashflow is the process of balancing your cash inflows (sales revenue and other income) and your cash outflows (your overheads, payroll, expenses and supplier bills) so you have a constant pipeline of cash.
Cashflow is the lifeblood of any business. Whereas income or profit can be seen as potential earnings, cashflow is the reality of the liquid cash you have in the business right NOW. And that’s why it’s such a vital way of measuring business success.
How do you measure your success?
There are many different measures for calculating your financial performance – and many different forms of vanity for how different business owners view their success.
For some it’s the number of companies, some the size of their company turnover, some it might be year-end profits. But even if you have profits of £1M on your profit and loss, that isn’t actually what you have in the bank.
Cashflow is what you REALLY have in the business – it’s the liquid cash you have available to you in the current moment – not when customers actually get around to paying your invoices.
In a nutshell, profit is what you’ve actually done, not what you’ve been rewarded for. And ensuring that you are rewarded for the service you have paid can be a real issue.
Being able to read your balance sheet
If you’re going to keep on top of your profit, cash and debt position, then having a good grasp of your financial statements is important – and the balance sheet is a key report to understand.
Your balance sheet is a photo of where you stand now, broken down to show the balances for your assets, liabilities and equity in the business. The net position tells you if assets are higher than liabilities and if the answer is no, that’s bad news. You don’t want a negative number as that shows you owe more money than you’re actually generating.
The average business owner generally either doesn’t understand their accounts in great detail or doesn’t want to know the bad news they may contain – so they don’t look. But it’s much better to know your balances, plan ahead and take action with your accountant.
Having an online accounting system like Xero makes it easier to see those reports and to use forecasting tools to predict your future position. Smart cashflow forecasting tools are even beginning to use artificial intelligence (AI) to forecast the drilled-down details of your cash – e.g. forecasting which invoices to target, grading customers by payment time and highlighting seasonal patterns and gaps that you can plan around.
Controlling the cash in your business
If you’re in control of your cash, you control the destiny of your company and whether you grow.
You put yourself back in the driving seat when more money is coming through the door, and that means you can make better decisions for you and the business.
Cash is king: without it you rely on other people; with it you control your own company.
If you’re looking at the big profit number at the end of the year, but not looking at cashflow, then now’s the time to get back in control.
Talk to one of our accountants in Essex about putting yourself back in the cash driving seat.