Cash flow and profit are both important in terms of gauging a company’s wealth and health. While profit can only indicate how much a company earns, cash flow is a good indicator of a company’s health and also predict its future prospects.
What is Profit?
The profit of a business is the balance money remaining after deducting expenses. A business is taxed on the basis of the profits earned. Profit can be categorized into three broad types, namely net, gross, and operating profit. These provide information about a business’s performance, its earnings in particular.
What is Cash Flow?
Cash flow is the movement of money in and out of a company. It is determined by summarizing expenditures on operations, purchasing inventory, operating costs, taxes, employee payments, etc.
Cash flow helps gauge a company’s liquid assets that can be used for business purposes while avoiding a need for loans. Positive cash flow indicates increasing liquid assets, while negative cash flow indicates otherwise. The health of cash flow indicates the ability of a company to reinvest, settle debts, pay expenses, and create a buffer against future financial challenges.
Cash flow and profits, both, are vital to every business. However, if you were wondering which of the two is more important, then your answer is cash flow. A company’s cash flow is a major indicator of not just its overall health, but also its future prospects. Here are reasons why this is so:
1. Cash Flow is Good for Growth
Positive cash flow is always good for a company’s growth, and over time this can be invested elsewhere to expand the business. It can be used in employee training, investment in equipment, and other vital business investments. This strategy is far more sensible than aiming solely for profits, as continual cash flow will lead to higher profits in the long run.
2. Cash Flow Indicates the Status of Business Health
A company can always appear profitable on paper. But cash flow statements are more reliable and provide a complete report of a company’s liquid assets. This in turn outlines how well a company is run and also its health.
3. Cash Flow can Highlight Operational Issues
Cash flow can help highlight operational issues by following the negative cash flow trend. For example, if a company’s sales are steady for a particular month, but client payments are delayed, this could result in a cash flow imbalance. The company may end up showing a loss for that month but an increased profit in the next.
4. Cash Flow Helps A Business Be Proactive
It is always great for a business to have cash in the bank. This allows it the freedom to take advantage of opportunities as they present themselves. This could be in the form of technology upgrades, outside expertise, and research and development. However, profits can allow you similar freedoms as long as it is not tied up in assets.
5. Cash Flow can Reduce Debts
Monitoring your cash flow allows you to run a tight schedule, enhance business operations, and ultimately pay off company debts. This reduces the overall burden on the company. However, relying solely on profits may eventually lead to late fees and overdrafts, in turn amounting to added debts.
6. Positive Cash Flow can Avoid Taking on Debt
For any business, a loan can be enticing especially when the profit margin is high. However, this can turn into a disaster for a business, as relying on a profit alone does not guarantee a bright future. This, in turn, may lead to more debts. However, with a steady cash flow, a business is all the more likely to come out unscathed in the event of an emergency and avoid debts, to begin with. A debt-free business is always an enviable asset.
7. Good Cash Flow Attracts Long Term Investors
Steady cash flow is the backbone of any robust business. A balanced financial graph will attract new investments. Long-term investors are more likely to collaborate with a business that has reliable cash flow.
8. Cash Flow Can Forecast A Company’s Financial Future
Cash flow is vital when forecasting a company’s financial future. Cash flow data monitoring allows a business to make informed decisions prior to investing. Profit, on the other hand, cannot do the same as profits are unpredictable. Therefore, it is difficult to predict a company’s future on the basis of its past profit data.
As outlined above, the importance of good cash flow clearly outweighs that of profit. Cash flow helps companies make crucial decisions based on the health of their business. These decisions eventually play a vital role in the upkeep and growth of a business. Public Liability Insurance can help a company to tackle unexpected problems and keep growing unhindered.
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