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Cash Flow vs. Profitability: Similar Financial Story, Different Chapters

No business is immune to the inner workings of cash flow and profitability. The two terms, although often misinterpreted to mean the same thing or something substantially similar, are, in fact, very different. And each one serves a distinct role in the financial viability of a business. Before exploring the nuances though, it’s important to understand the basics underlying each.

What is Cash Flow? The term cash flow refers to the movement of money in and out of a business over a specified period of time. It is focused on the availability of cash to meet a business’s short-term financial obligations, such as paying rent, utilities, technology expenses, employee salaries, and supplier invoices. Cash flow is a crucial marker for a business’s day-to-day operations (if it does not pay its bills on time, it will no longer have what it needs to function properly), as well as a specific indicator of its overall agility. Without positive cash flow, the smooth financial navigation of the business will inevitably stray off course or may even cease all together.

What is Profitability? As you may have expected, profitability is not the same as cash flow. The term profitability has to do with the measurement of the financial gains or losses that a business generates. Profits are calculated after expenses are deducted from gross revenue. In the simplest terms, it is the revenue left over when all the business’s expenses have been paid. As opposed to cash flow, profitability is a longer-term marker, providing insights into the enduring sustainability and success of a business.

Which One is Most Important?

Most financial analysts would agree that neither cash flow nor profitability is more important than the other. In fact, the two metrics go hand and hand. Without cash flow, the business will be unable to operate in the day-to-day realms of rent payments, supply orders, and payroll demands. Without profits, however, the business will suffer in the long-term causing it to miss opportunities, lose investor prospects, and slow growth. While related in that they tell the business’s financial story, cash flow and profitability are each a different chapter in that story depending on the type of business, which phase of growth it is in, and other variables. Take the following examples:

  • Startup phase businesses. It has been noted that one of the top reasons a business fails is because of a lack of working capital or cash flow. This is especially important to new businesses. In the startup phase, cash flow is imperative to supporting the expansion of operations, the purchase of inventory, and the hiring of staff. As the business is just getting started, it needs cash to invest in launching new products or services and gaining traction in its marketplace. It likely needs to sacrifice profitability for the short-term. In fact, it’s rare for businesses to be profitable in the startup phase. As such, prioritizing cash flow over profitability is a logical path.
  • Seasonal businesses. Businesses that have extreme upturns and downturns in their business will experience significant fluctuations in cash flow throughout the year. A landscaping business, for example, will experience higher revenue during spring and summer and lower revenue during fall and winter. As such, there could be months with no revenue at all, but when expenses still need to be paid. While the expenses may decrease (they likely only have seasonal employees), loans on equipment or storage payments may remain the same. In these types of businesses, an accurate and thorough management of cash becomes crucial to bridge the gaps between seasons (and revenue). While overall profitability is, of course, important to these types of businesses, ensuring that cash flow covers the slow time is often the priority.
  • Profitable businesses without cash. Some businesses appear profitable on paper because they show a positive net income. However, they could simultaneously be experiencing issues including high accounts receivable, excessive inventory, or high interest debt obligations. Each of these scenarios, among others, will negatively impact the business’s cash flow, but have yet to show on the financial statements, making it appear as if the business is profitable. This is where managing cash flow becomes critical for meeting immediate financial obligations, regardless of what profits show on paper.

In these ways, and others, understanding the differences between cash flow and profitability based on the particular scenario is crucial to make informed financial decisions. While profitability is a strong indication of the overall health and success of a business, cash flow is a marker for its day-to-day operations. Striking the right balance of focus between the two chapters helps to dictate the business’s long-term financial stability story. However, this balance will vary from business to business and depend on the lifecycle stage or industry in which the business operates.

At Agile Planners, we provide strategic guidance and outsourced CFO services to companies of all sizes. We can help provide the strategy your organization needs for the growth you want. We understand that no two organizations are the same. And with our experience and financial knowledge, we can help develop the right strategic plan for your business to grow and reach its goals. Simply, we’ll be your trusted partner, so you can focus on running your organization. Contact us today to learn more about how we can help.

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