Cash Flow vs Profitability: What Is the Difference?
If you’re a small business owner, you know how difficult it can be to keep a healthy amount of working capital in your account at all times. Unusual, negative or erratic working capital issues can cause your business to struggle to grow or even remain at the same level of profitability. If you’re having difficulties grasping your financial situation, learn the difference between profitability and cash flow today.
Cash Flow Defined
Basically, your flow of cash is determined by the amount of money that comes in and out of your company over a set period of time. A positive flow means that, on average, your business is earning more than it’s spending. Negative flow means that your business is slowly spending more than it’s receiving.
Short-term issues with your inflows and outflows can be solved with a healthy amount of working capital. A short-term negative inflow doesn’t necessarily mean your business isn’t profitable.
Long-term inflow and outflow issues, however, can be dangerous. Use your flow of cash calculation to find your break-even point for your business. Earning more than this makes your business profitable in the long run.
Every business owner wants a profitable business. However, you should be cautious when you use the term profitability. Profitability simply means there’s an inflow of cash. Unfortunately for many small businesses, this can also come with extreme outflow of cash.
Just because your business has a high profitability calculation doesn’t necessarily mean that it’s sustainable or successful. Look at both the inflow and outflow totals to determine whether you’ve hit the break-even point or not.
Solvency and Liquidity
Other helpful measurements are solvency and liquidity. Liquidity is similar to your working capital amount. This term describes the available capital on hand to pay off debts and cover operating expenses.
Solvency is similar, but has a much longer scope of measurement. The solvency of your company is the long-term amount of equity, debt, inflow, outflow and other factors. Calculating your business’ solvency is an essential step to determining whether your business is on the road to financial success or struggling to keep the doors open.
Don’t let your profitability deceive you, but calculate your company’s cash flow, liquidity and solvency today to discover its financial health. If you’re company has too much outflow and not enough inflow of cash, consider using financing or altering your business strategy to keep your company growing successfully.