5 Key Things To Know About Cash Flow and Profitability
If you’re a business owner (particularly a new one), you might not be sure how cash flow and profitability differ. Even if you know that cash flow is concerned with accounts receivable versus accounts payable, and profitability is concerned with revenue versus expenses, you might need a more detailed breakdown of their differences. Here are some basic concepts to help your understanding.
1. Cash Flow Defined
The term “cash flow” itself can help you visualize how it works. It has to do with the amount of money that flows in and out of your enterprise. In other words, it’s a snapshot of your business bank account. You have positive cash flow if the amount you make is more than the amount you pay out. At first, it takes time to build up a positive cash flow. Having a cash reserve (six months is ideal) is imperative during this crucial time.
2. How To Analyze Cash Flow
Here’s an easy way to determine cash flow: Take the amount of money you’ve made from your product or service, and subtract all business expenses. Include product costs, rent, bills, and payroll. Then, add in cash from investing activities.
3. Profitability Defined
Revenue and expenses are part of the definition of profitability, but there’s more. It has to do with the planned, booked expenses and income that occur within a set period. It’s different from cash flow because it’s measured at predetermined intervals rather than at any given point in time.
4. How To Analyze Profitability
The prediction of current viability and future growth based on revenue and expenses is the cornerstone of profitability. There are several methods of measuring profitability; taking a look at online resources such as Quickbooks can give you specific formulas that you or your accountant can use to get an accurate read. Analyzing key metrics will help you discover why your business is (or isn’t) healthy, and what you can do to move the needle in a positive direction.
5. The Bottom Line
To be a successful business owner, it’s important to know that the ability of your company to make money can’t be measured solely by how much you currently have in the bank. Instead, a holistic assessment of financial health includes an accurate determination of both cash flow and profitability.
Cash flow and profitability are important metrics for determining the health of your business. Keep these distinctions in mind as you plan.