It could be one of the most asked questions by trade contractors: should I be focusing on my cash flow or my profits? It can be a difficult question to answer, as cash flow and profit both play critical roles.
With cash you pay your employees, vendors, suppliers, rent, and bills – so without it the business wouldn’t be able to survive. While profit is the surplus you have after all the expenses have been paid or deducted from your revenue, it’s also the basis on which your tax is calculated.
While profit is essentially the big picture of a business, you need cash flow to keep it running.
Your cash flow can come from a number of sources including customers, receipt of a loan, or even interest on savings and investments. Obviously, positive cash flow is preferred. Positive cash flow means you can make further investments in your business (e.g., hire new employees), whereas negative cash flow indicates more cash is flowing out rather than coming in.
A common misconception that many trades businesses carry is that profit is the most important indicator of a successful business. While having good profits is important in the long term, cash flow is a key indicator of good financial health.
Cash is king
There’s a reason the saying ‘cash is king’ exists. While your business can have a healthy profit on paper, cash is what you use to pay staff and buy materials for jobs. Having positive cash flow also provides protection against loan defaults or foreclosures and helps the business run even if sales are in a slump. Having cash on hand at all times is critical, but having good cash flow indicates the business’s ongoing ability to generate and use cash.
Your business’s cash situation is known as the liquidity position of the business. The more cash and the closer your assets are to cash, the more liquidity your business has. As a business owner, you ultimately aim to provide greater financial returns than the interest earned by holding your free cash in the bank.
While having cash is good, there is such a thing as having too much, as cash sitting around doesn’t earn anything. It’s important to find the right balance between having enough cash (or liquidity) to protect your business in leaner times, but still making sure to invest money back into the business to keep it growing.
Having good liquidity and cash flow is especially important during times when obtaining loans or credit is difficult. If the business has cash available to reinvest, it can be better to take advantage of opportunities you may have to expand.
Having strong cash flow undoubtedly provides the capabilities a business needs to invest in its future growth. From hiring new employees, buying new vehicles and inventory, providing training and even improving technology, positive cash flow puts your business in a better position to grow.