Cash is the most important thing. It's been said before, but do you know what it signifies?
I learned to manage cash flow at business school in a classroom. However, it didn't have any significance for me until a few years later in creating my own business. As my earnings and sales were soaring and my cash flow dipped, so did my cash flow. What was once an academic exercise was taking place in real life when I was at risk of being in debt and not having enough money to pay the bills, all while it seemed that things were going well.
In the decades since that time, I've noticed many of us are caught in the same trap that enticed me: We believe in profits, yet we spend money. Our culture encourages us to think that way. It's part of our culture. The most common business plan printed on a napkin is all about selling something at a price that is more than what it cost to construct it. In the long run, it should be enough. However, that's not always the scenario.
The conclusion is to follow my advice rather than what I did. Be aware of how much cash you have. Do not confuse some money with profits. I was able to get through the short-term cash flow issues, but it was a matter of taking on additional mortgages and many debit card balances.
The issue when it comes to cash is that we often overlook it. We are conditioned to think of profits. However, we use cash. The problem is that cash and cash are two different things.
The Profit is calculated after subtracting the cost of expenses from sales. It doesn't matter if the client has paid you or if you've paid your invoices. The deals are recorded when you mail out your invoice. In the same way, expenses are accounted for to have a cost in your accounts even if you haven't yet paid for the invoice.
Revenue is the money that comes into the company. For the majority of finance and accounting reasons, it's the same thing as sales. However, technically, it can also refer to sales of assets and cash coming through as investments or loans.
However, cash is what you require to pay your bills - the actual amount of money you have and in the bank account, you have.
The fundamental issue in knowing the distinction between Profit and cash is the basic accounting and financial guidelines. All over the Western globe, people live with a business practice founded on profit and loss statements, sometimes known as the income statement. It reveals the company's results over a certain time frame, usually one month, a quarter (three months), or even a whole year.
It begins with the highest sales before displaying direct costs (also called unit costs and the cost of goods sold COGS) below that. It subtracts the direct cost from sales to show gross margin.
It then lists the expenses, including fixed costs like pay and rent and discretionary fees like advertising and marketing. Taxes and interest also count as expenses, yet they are often listed separately from operating expenses. The Profit, which is at the bottom, is the result of subtracting costs (including taxes and interest) out of gross Profit.
The grandfather of all accounting statements is the basis for numerous business discussions. It also defines our language. We speak of "the highest" line" as sales and " the bottom line" as profits.
The problem is Profit and loss seem to represent the complete business's health. However, it's not.
A company delivers its goods or services to a business or customer along with an invoice. It is a common occurrence in business-to-business sales. The value of the invoice is added to the sales for the month and billed as sales. However, it's not cashed to the bank.
The money is placed in a bookkeeping category dubbed accounts receivable until the check is received and is deposited in the bank. The time interval between sending an invoice to receiving cash is known as collection days or the collection time. The challenge for businesses is that all the money in accounts receivable is shown in sales profits; however, it isn't in your account. You aren't able to spend it.
Profitable businesses can fail due to having excessive funds in receivables, but they do not have enough cash in the bank. It is why they struggle to get their invoices paid in time. The funds were credited to sales but didn't make an appearance in the banks. In the end, being profitable did not make a difference in preventing business failure.
The majority of product-based companies, like stores, must purchase the items they sell in advance before selling them. Manufacturers and assemblers need to buy the components and supplies before they can create and market the final product, which could cause lots of cash flow issues.
It's known as inventory. It includes products that are resold, materials to manufacture, and components to be used in assembly. Inventory purchases don't make it into profits until they sell, but it's gone from the bank when it's used.
For companies that rely on inventory, managing inventory can be crucial to cash flow. It's easy to get cash tucked away in stock that is left on shelves for too long or is never sold. The money disappears in the bank's account. However, it isn't reflected in the profit and loss report.
The reverse of accounts receivables is accounts payable, which refers to the cash owed by a business to its suppliers.
A period of longer than 30 days to pay your invoices is beneficial for your cash flow. Every dollar that you keep in your accounts payable is a dollar which is considered an expense that reduces profits yet is still an individual dollar in your bank. It is yours until you cash it out. Profits are deducted from expenses as they are incurred and not when you pay them.
Thus, payables are the reverse of receivables. With receivables, your customers hold your money, while with payables, you've got your vendor's cash.
The expression "the lowest line" refers to the Profit, the top line of your profit and loss report. It's used to refer to something similar to a conclusion or perhaps the most crucial outcome. It is why the main goal for entrepreneurs is cash flow, not profits.
Profitable companies may run out of cash because of a lack of cash flow. That's the truth. There's no other way to avoid it. To run a business, you need to be mindful of cash flow, not only profits.
Disclaimer. The opinions and views expressed in this article are the authors Andrew Napolitano.
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