There are a number of financial objectives that you are working towards when running a business. This includes generating a profit or raising your profitability, which gives you the ability to reinvest into your business as well as use to reward workers and stakeholders. It will also involve maintaining cash flow across your operations, enabling processes to run smoothly and ensuring costs are met in a timely manner.
Profit and cash flow are two separate financial elements, which you will track individually across your business. However, there is often a correlation between the two that means the one will be impacted if the other changes.
We explore the relationship between profit and cash flow in a business and what you can do to improve both for maximum results.
- What are profit and cash flow?
- How are the two connected?
- Our top tips for improving profitability and cash flow
What are profit and cash flow?
By definition, profit and cash flow are different. Profit indicates how much money a business has made i.e. your sales/revenue, less the cost of sales and overheads. If you seek to increase profit, this will usually come from increasing revenue or lowering costs.
Cash flow refers to the net flow of cash in and out of your business (how much you are bringing in versus how much you are spending). In an ideal world, you want to be bringing in more cash than you are spending, but at the very least, this should be balanced to enable you to cover your outgoings.
As they are accounted for separately, it’s entirely possible to have good cash flow, but poor profitability. Similarly, you may generate a profit but still have poor cash flow if your invoices are not being paid on time or you are growing fast.
It’s crucial to maintain both good profit and cash flow. A lack of profit will inhibit your ability to grow due to the lack of finance to reinvest into the business, unless you seek external finance. It will also limit your ability to pay dividends, both as a result of poor cashflow and poor profitability.
On the other hand, limited cash flow can impede your daily operations, leaving you unable to cover the costs you need to operate (including supplies, staff salaries, loan repayments, and so on).
Over time, both could cause issues in your company and lead to losses.
How are the two connected?
While cash flow and profit are monitored separately, having a favourable level of both is a good sign of a healthy business. As we have already mentioned, they can impact one another.
If you increase your profit levels, you give yourself a wider financial margin to work with, improving your cash flow.
Growing profits can be used to build up cash reserves which act as a safety net when increased expenditure is required or if revenue is down, meaning you can continue to maintain cash flow and meet your financial commitments, even in trying times.
Similarly, if you optimise cash flow across your venture, it means you’re more likely to have better cost management. This will be invaluable as you aim to grow sales and revenue and maintain profitability.
Having good profitability and cash flow will also fuel any growth ambitions you may have, with profit being used to scale your business and invest in new resources and processes while maintaining your cost base to avoid a financial strain.
Our top tips for improving profitability and cash flow
Due to the importance of having good cash flow and profit, it’s in the interest of every business to do what it can to improve both. Below, we’ve listed our top tips to help.
Manage costs
Managing your costs is essential for promoting both profit and cash flow. For maximum profitability, you want to limit your costs as much as possible while growing your sales and allowing your operations to meet demand and customer expectations. For improved cash flow, you need to ensure your sales are collected in promptly or that you finance your invoices. This will allow you to maximise cashflow and you meet your expenditure.
There are many ways to manage costs, but standard methods include conducting regular audits of your expenses to eliminate unrequired costs, shopping around suppliers to find competitive deals, reviewing your pricing model and seeking cost-effective processes.
Use your profit wisely
A constant challenge for business is healthy profits, and yet cash flow is poor, as it means you are likely to run into debt and put your business in jeopardy.
It is key to use excess profits wisely such as paying any outstanding debts you may have or strengthening your operations to make them more cost-effective, whilst maintaining cashflow.
Use your profits and cashflow to build up adequate reserves that you can call upon when needed. Similarly, you should identify valuable ways to invest your profit so that it actively boosts your business in the long term.
Utilise external support when needed
Many lending solutions on the market can support your profitability drive (such as through growth finance) while supporting cash flow (through short-term loans, invoice finance and trade finance).
By understanding the external funding options available to you and their role within your business, you can access the support you need to achieve your profit and cash flow goals or intervene if they are at a lower level than you would like.
If you are unsure of the different external finance options available to you, speak with an independent financial broker who can take you through the help available and enable you to develop a plan to improve your business’s financial situation.
Align your priorities with your goals
While it is ideal to have healthy cash flow and profit, there may be times when profitability or cash flow need to take a back seat to achieve your goals.
For example, if you are growing as a business, your cash flow may shrink while your expenses increase to enable growth, and you wait for your revenue to increase in response to your new processes. Similarly, if you face a financial issue or falling revenue, your profitability may take a hit whilst you maintain cash flow, so you can continue to meet the costs required for your operations.
Reduced profit or cash flow isn’t necessarily a problem if it’s temporary. However, if it becomes a long-term issue or spirals out of control, it’s essential to act promptly and consider external support.
Conclusion
Profit and cash flow are critical parts of a business’s financial health. While they are defined and accounted for differently, they are connected in that they affect your ability to operate effectively and grow.
One also can impact the other, so it’s essential to keep on top of both and do everything you can to optimise them. By doing so, you can enjoy the rewards of a financially stable company, where your expenses are consistently covered, and leftover funds can be reinvested back into your business to fuel growth.
If you are looking to improve profitability and manage cash flow in your business, we can point you in the direction of support and finance solutions that will help.