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What if I told you Cash Flow was more important than Profit?
Cash flow is more important than profitability in the early stages. It's easy to think that you're doing okay just because you see money in the account.
In this blog post, I will clarify the difference between cash flow and profit, how to run lean without sacrificing quality, and the importance of strategic financial planning.
Im also covering some nuances with inventory management, and accounting practices — since I see these as appropriate side junctures that affect cashflow.
The Critical Role of Cash Flow
Cash Flow vs. Profitability
I once had an accounting client come to me at the second year mark, just devastated that he was not profitable yet. He was honestly ready to throw in the towel and quit the whole business because he wasn't seeing profit yet.
In his mind, by the second year of his company, he should be out of the red and making profit each month.
But when we dove into the numbers, all of his financials looked great. Every cateory was trending up, his cash flow was great, he was bringing in revenue. I took time walking through with him how incredible his numbers were and disclosed that its VERY normal to not be profitable till year three.
Once we were able to adjust expectations, he was able to move forward, and he still owns that business to this day.
Profitability is the ultimate goal for any business, but in the early stages, cash flow takes precedence.
Profitability refers to the financial gain when revenue exceeds expenses, while cash flow is the net amount of cash moving in and out of your business. The inverse is much worse: you can be profitable on paper, but if you don't have enough liquid cash to pay your bills, your business could quickly find itself in jeopardy.
Running Lean: A Strategic Approach
Avoiding Expensive Contracts
I have had clients who were trapped in contracts with "providers" long before they had any money moving through their accounts. Be cautious of companies targeting new LLCs with costly contracts that may not align with your immediate needs.
We often get caught up in the excitement of starting something new, and we want everything to be JUST right, and we take on too many expenses too soon.
Examples of this can include: photography for your "brand" or hiring third party social media experts to handle your first campaigns. These large expenses aren't making you money in the short term, and often those "long term" strategy moves need to be reserved for when you have both profit, and an established customer base.
Efficient Inventory Management
Speaking of established customer base, I have been involved with companies that purchased WAY TOO MUCH inventory, hoping for those niche clientele that never came. This EATS at your initial costs. To manage it wisely:
- Don't over-invest: Avoid tying up all your capital in inventory. Excess stock not only consumes cash but can also lead to depreciation and obsolescence.
- Stay broad yet focused: While it's tempting to specialize, offering products that are too niche can limit your customer base. Balance specificity with broader appeal to attract a wider audience.
- Understand bank perceptions: High-cost inventory can be a red flag for banks, especially if it's rapidly depreciating. (such as seasonal items) This could affect your ability to secure financing.
Planning for the Long Haul
Set realistic expectations for your business's financial journey:
Anticipate delays in income generation: It often takes longer than expected to turn a profit. Plan for at least three years without positive cash flow.
Align with industry benchmarks: Research financial and performance metrics within your industry to set achievable goals and measure progress.
Accounting Practices: The Backbone of Financial Health
Cash vs. Accrual Reporting
Understanding the difference between cash and accrual accounting is vital:
- Cash accounting: Records transactions when cash changes hands. It's simpler but may not provide a complete financial picture.
- Accrual accounting: Records income and expenses when they're earned or incurred, regardless of when cash is exchanged. This method offers a more accurate view of your business's financial health.
The Importance of Accurate Record-Keeping
- Enter all your bills: Consistently tracking expenses ensures you have a clear understanding of your liabilities.
- Hire a reputable accountant: Investing in professional accounting services can save you time and prevent costly errors. A skilled accountant will set up clean books, making it easier to manage finances and impress potential investors or lenders.
Building a Solid Team and Reputation
Collaborate with Reliable Subcontractors
Surround yourself with subcontractors who have proven track records and good reputations. A strong team contributes to:
- Quality work: Reliable partners deliver consistent results, enhancing your business's credibility.
- Customer satisfaction: Professionalism at all levels leads to better customer experiences and repeat business.
- Networking opportunities: Reputable subcontractors can introduce you to valuable contacts within the industry.
Preparing for Financing Opportunities
If you plan to seek financing:
- Know what lenders look for: Understand the criteria banks use to evaluate loan applications. This often includes cash flow statements, credit history, and asset valuations.
- Present a strong financial case: Well-organized financial records and a solid business plan increase your chances of securing funding.
- Avoid assumptions: What you think looks good to a bank might not align with their assessment criteria. Consult financial advisors to ensure you're meeting the right benchmarks.
