What does a business need - cash flow or net profit?

If you started a business last year and it now has more cash than you put into it, is it profitable?

According to the way accountants measure things, you have a profit for a given period if you add up your sales, subtract your expenses, and end up with a positive number. If you end up with a negative number, you have a loss. For an explanation and example of the difference between cash flow and accrual accounting, see cash versus accrual.

Unfortunately, adding up your sales is not the same as adding up the cash that came in, and your expenses won't always equal the cash that went out. For example, you have sales without receiving cash by making a sale on account, and you receive cash without having sales when you borrow money or receive a customer payment on account. Likewise, you incur an expense without spending cash when you make a credit purchase or when you record depreciation on the books. You can also spend cash without incurring a current accounting expense when you buy an asset such as a building or a computer.

Cash or profit?

So which do you want - cash or profit? Well, you want both. To keep your business afloat for the short-term, you need cash to pay suppliers and employees (perhaps even yourself). In order to obtain that cash, you may have to expedite collections from your customers, stretch out payments to your suppliers, or borrow from your bank.

Over the long-term, however, you will need to show a profit. In other words, the sales that you ultimately realize in cash must exceed the expenses that you ultimately pay in cash in order to maintain a successful business.

It is important that your business plan for both cash flow and profits. We can help you establish simple systems for both.

© Copyright 2001 Raymond S. Kulzick. All rights reserved. 010205.

This publication provides business, financial planning, and/or tax information to our clients. All material is for general information only and should not be acted upon without seeking appropriate professional assistance.

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Copyright © 2001 Kulzick Associates, PA - Last modified: September 13, 2008