CASH FLOW VS PROFIT: WHY ARE THEY DIFFERENT?

Dash

EPISODE 52

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ABOUT THE SHOW

Dash

It’s common as a business owner to look at your profit and loss statement at the end of a period and wonder why the profit figure doesn’t equate to the money in your bank account.

Business owners are often scratching their head in disbelief wondering where the money is, given the profit being reported.

Both profit and cash flow are critical components to running a successful business. Profit is what generates cash flow and cash flow pays the bills and keeps your business running. But they are two very separate things.

In this episode, we have an in-depth look at the differences between profit and cash flow and discuss, that despite being very dependent on each other, they are in fact very, very different in they way they operate in your business.

WHAT YOU'LL LEARN

Dash
  • The difference between cash flow and profit
  • How profit and cash flow operate differently
  • Why it’s possible to have a high profit with little cash flow
  • Why you can have cash flow with no profit
  • Tips you can use to improve your cash flow

EPISODE TRANSCRIPT

Dash

Jason: You’re on episode fifty-two of the Business Made Easy podcast.
Let’s do this, Mia.
Mia: You’re on the Business Made Easy podcast where we make business easy. Here’s your
host, Jason Skinner.
Jason: Good day. Good day and welcome to the Business Made Easy podcast where we make
business easy. Jason Skinner, your host here for another week of the podcast which is all about
growing your business bottom line and giving you a better life as a result. I, thank you so much
for being this week and I am excited. I’m going to tell you we are on episode fifty-two. This is
the fifty-second episode of the podcast, that means we’ve been bringing this out every week
for a year now and I can’t believe it’s the fastest year of my life, I swear. , but it’s been a lot of
fun and a lot of work, putting this together but, but I wanted to just, firstly, thank you for, for
tuning in each week and, and those of you who’ve subscribed and listened each week, thank
you so much. , if you are new to the show, make sure you hit the subscribe button but, it’s just
been a, a jam-packed year. , I don’t know if you know how much work goes into putting these
podcast shows together. There aren’t just magically appear on your phone each week and
there’s was a tremendous amount actually but I’ve gotta — I’m being thankful to have a, a great
support team behind me. My wife, Melissa and, my, PA, Leah and, and our audio, lady, Linda and
her team, they, every week, put this show together and, and, and get it all to make sure they all
come out every Friday morning and , they had just been doing a fantastic job. So, thank you to
them and again, thank you to you for tuning in as well. Alrighty, we have got a great show today
but before I get into that, if you’ve, not joined, our Facebook Community yet, be sure to do so.
You can do that at over at, https://businessmadeeasypodcast.com/community and there’s a
great group of people over there, all talking all things, business and, really supportive group
actually and it amazes me continually the diversity I guess of skill sets and
(2:00)
professions and, and business owners that are over there. And we’ve got everyone from
lawyers, you can get help with the legal stuff. You’ve got, you know, marketing, social media
help. I mean, there’s a great group of people over there, so if you need help with anything
within your business. Be sure to join The Business Made Easy Podcast dot com facebook group
and, and jump on board and be part of that https://businessmadeeasypodcast.com/community.
Really great group of, people. Alrighty then, let’s get into today’s show. It’s a great episode
today, in that we are talking about probably one of the most common problems that I see
business owners, mistakes. I see business owners making or not understanding and I see it
almost daily in, in public practice. And I’ll, I’ll explain a little scenario and we’re gonna be talking
today about the difference between cash flow and profit in your business. Now they’re both
two critically fundamental, figures or, or, or numbers that, that you need to be aware of in your
business but you also — that’s not where it stops. You also need to understand how they work
together and how they work against each other as well in your business because they’re not
the same thing. A lot of people — and I’ll go through this scenario — is that I’ll, I’ll prepare a, a set
of financial statements and accounts etcetera, for, for a client. And, they’ll come in and sit down
with me and we’ll, we’ll open up the books and we’ll — I’ll sit there and I’ll say to them,”Oh look,
Jo and Mary, you, you have a got a fantastic year in business this year. You’ve, you’ve made two
hundred thousand dollars in profit.” And the next thing that usually happens at that point in
time is that Jo and Mary look at me and say,”, we don’t have two hundred thousand dollars in
the bank. That can’t be right. There’s no way in the world we made two hundred thousand
dollars because we only have, — we’re actually an overdraft and we don’t have any money in
the bank and
(4:00)
that’s just gotta be wrong.” And this is where the conundrum starts because Jo and Mary are
thinking that, the two hundred, the profit is actually the cash flow. Now when we look at profit,
profit is different from cash flow because when we’re looking at profit, profit is just a number
that, that, that drops out of the bottom. Once you add up what you’ve sold during the year and
you take off your expenses, for running your business during the year, that’s what profit or loss
is. It’s really just, looking at a set time period so a profit and loss can look at, you can run a profit
and loss statement for a day, you can run it for a week or a month or a year. But it’s, it’s
whatever period that you choose, to look at, that is the, all the income that you, made or, or
products that are sold in that, revenue that you generated in that period less the expenses for
that same period and that’s all profit and loss is. It’s, it’s just a, it’s a, it’s a number that drops out
the bottom to see that you’re making more, and you’re selling things for more than you are
paying for them. When I, when I say paying for things, I mean rent, wages, superannuation, cost,
you know, advertising, social media spending, advertising, rent, all, all the, all those things so
once they will be taken off, the resulting figure should be a profit figure. Cash flow, for instance,
cash flow though is completely different. Cash flow is the money that is flowing in and out of
the business. So cash flow is like liquid and always use the analogy that if you think of, profit, as
the size of your car. So when you,
(6:00)
when you make a profit, the bigger your profit, the bigger your car is. Cash flow is like the fuel
that runs that car. So cash flow is the fuel running into the, into the tank of the car when you go
to the service station, the gas station, you fill up the tank, that’s cash flow going in and then
you’re running your business, the, the, the car you’re running it along and it’s using cash flow to,
to exist. So cash flow pays the bills, for instance. Cash flow pays the wages each week and the
superannuation and the rent exudes. It pays what it cost. Cash flow pays your loan down. , cash
flow pays your supplies and creditors so it’s different to profit and loss. Now, so for that reason
you won’t ever have or very rarely, I mean if you just start a business today, it might be the case
but you very rarely have, a situation where your profit is going to one hundred percent
represent the cash that’s come in, come in to your business or the cash that’s in your bank
account. Profit won’t equal with your bank account and here is the reason for, for this. Let’s
just say, we start business today. , it’s a brand new day; we wake up in the morning, we save
some funny reason, we might just start a business. So this business might need rent. It might
need, it might need a premises to apply this so we’re gonna have rent. , it’s going to need — ,
we’re gonna incur expenses before we actually start this business because we can’t just start a
business unless you’ve got something that you’ve already have, I guess, and you just sold it but
even then you still got some form of advertising cost of something like that too, to even sell it.
Let’s just say, for instance, our startup cost to get our business off the ground, we’re gonna
need twenty thousand dollars of, of things that we’re gonna have to start. We’re gonna have to
buy some products.
(8:00)
we’re gonna have to buy some things to sell. That is going to require cash flow. So that cash has
to come from somewhere. It can’t come from the profit that we made in our business because
the business hasn’t made any. We haven’t sold anything. It’s day one of our new business.
We’ve got twenty — we’ve got to spend to spend twenty thousand dollars on startup cost; we
need that money from somewhere. So that money will normally come from maybe a bank. We
could go and borrow the money from a bank. It might come from savings that we have in our, in
our personal bank account, that we’re gonna just invest that, twenty thousand dollars as a
shareholder into the business and that’s gonna start the business off. Now, there, day one,
we’ve already got a difference between cash flow and net profit because we haven’t made any
profit. We haven’t sold anything but we’ve had cash come into our business. We’ve had cash
flow come in like fuel in the, in the car. So that money has come from another source. It hasn’t
come from profit so that’s a cash. Then we might go along for a bit; we bought our goods and
we’re up and running and we’ve got stock now. So we’ve, we’ve invested some of that, twenty
thousand dollars in stock. We bought say, ten thousand dollars worth of stock. Well, when we
pay for that stock, that’s a cash outflow. So that’s cash going out of the business because we’ve
had to pay our supplier. Again, we still haven’t sold any items. We’ve only just bought the items.
That’s all we’ve done. We’ve put twenty thousand in and then we bought ten thousand dollars
worth of goods and, and products to sell and pay the supplier. So that’s a cash outflow and that
again still doesn’t resemble our, our, our bank balance now which is ten thousand dollars. It
doesn’t represent any profit or loss
(10:00)
because we haven’t, we haven’t sold anything yet. We haven’t made a profit. So again, it’s
another distinct difference as to the cash flow might be different. Now let’s just say for
instance, that somehow, we get lucky on day two of our business and, we get our first customer
come in the door and they wanna buy all the stock we have. But this is just a hypothetical
situation. I’m just working with you just to keep the numbers nice and simple and, keep it,
relatively easy to understand. But let’s say, the customer comes in day two and wants to buy all
our stock out. Ten thousand dollars worth of stock we paid for. We’re gonna sell that stock for,
let’s put a, a, a fifty per cent markup on it. So we’re gonna sell that stock for, twenty thousand
dollars, let’s just say. We’re going to sell the stock for twenty thousand dollars. Now, the
customer says,”I wanna buy all your, stock, will you give me trading terms because I don’t have
the twenty thousand dollars cash to pay for the goods yet.” So I say,”Yeah, no problem, I will
give you, you know, a thirty days to, to pay me.” Which is an ideal — mind you, you don’t go do
this but that’s certainly I’m just using this for an example. So if I was to run a profit and loss on
the day of that sale happening, again, what will have? I will have a ten-thousand-dollar, profit
from the business because I sold the goods for twenty thousand, I bought them for ten
thousand, that means that I now have a ten thousand dollar- profit but I don’t have that extra
ten thousand dollars in my bank
(12:00)
because it’s sitting on my outstanding, customer’s register at that time. It’s sitting on my
account receivable ledger waiting for that cash to come in. And that’s another area that the
cash won’t equal the profit because, yes, my profit and loss says that I sold twenty thousand
dollars worth of products but my bank account doesn’t show twenty thousand dollars worth of
products because I haven’t, actually received the cash yet and that’s, that would be cash into
the business. So you can see that this is always going to be the difference between cash and
profit, cash flow and profit is always going to be different. Now, the critical thing is cash is king,
okay?I have seen plenty and plenty of businesses, make lots and lots of profit but not have any
cash flow, And this normally happens, if you haven’t got cash flow you can’t pay your bills. Now,
let’s say, from my example where I sold my twenty thousand dollars worth of, products and the
customer, doesn’t pay me for thirty days and then when the thirty days go by, he or she doesn’t
pay me for 45 days, I can’t buy any more. I don’t have I’m running low on cash so I can’t pay all
my bills if I don’t get that cash into my business. And this is where this is where a lot of
businesses could generate greater profit but not have strong cash flow. And you’ve got to have
a strong cash flow to stay, stay viable in business because cash is king as I say. Cash pays the
bills. Cash pays the wages. Cash pays the rent. Cash pays all those, all those expenses and, and
it pays you too. So I would — starting a business with putting twenty thousand dollars in, I want
a return on that money.
(14:00)
I want some from a dividend at some point in time. Well, those dividends can only be paid from
cash as well so you know, yes, I’ve got to make a profit but the cash there to make, to, to make
the payment of dividend. So this is where, this is — because if, if you think about that, if I don’t
get a return on that twenty thousand dollars, well, I’m really not, doing myself any, any favours
because I had a choice. I could have invested that twenty thousand dollars in a term deposit or,
or a fixed deposit at the bank and got, got a return on that money. So there’s has been an
economic cost of me investing that money into my business, I need a return on that money and
the cash has to be there to generate that return and give me that return. So some of the some
of the areas that, I guess cash can be, locked up if you like and something to pay attention to is,
some of the common areas, stock. So if we, , buy stock, buy too much stock then we might end
up having to pay for that stock well before we actually, sell the stock. So it might be sitting on
your shelves and, you know, while the stock is sitting on your shelf, that’s money not in your
bank. So , that’s where , one of the key metrics that I love to look at with clients that do carry
inventory whether they’re on online business or, or a, a bricks and mortar business, if you’re
carrying any sort form of stock at all, one of the ratios we look at is the stock turn rate. And that
right tells me quickly and easily how often you’re turning that, selling that stock, basically. How
many, how many days a year it takes to sell and turn that stock over to, to replace it? Because
it’s a really, really important, calculation, because, the lower that number is,
(16:00)
the quicker I’m, getting my money back in the bank. The other important measure area that,
that, cash can be vastly different from profit and affect your, cash flow is in, your accounts
receivable. Like in my example, where I have the customer wanted, want me to let him pay over
thirty days, well, while that they’re sitting on — if you’ve got, accounts receivable or debtors, as
we call them, customers that haven’t paid you sitting on, your books, then that’s money that’s
not in your bank account. That’s in their bank account. So they’re using your cash flow to, , to
fund their activities. So you really want to wanna get that money back in your bank as quickly
as possible. Now, the measure that you — so I’m trying to give you some practical measures
here that you can, measure this, tangibly. The one that I would look at here is your debtor days.
It’s what we call your debtor days or accounts receivable days and this is the number of days on
average it takes for you to collect your outstanding, moneys. Now, the lower that number, the
better. So in both of those cases, stock turn rate or inventory turn rate and , debtor days, the
lower that number, the better that is for your bottom line and the better it is for your, bank
account because that, that money, is, is in your — back in your bank quickly and your customer
has paid you. Another, another area that people often, often forget where their cash is going
and why it’s different to their profit is if you’re reducing a loan of any type. You might have a, a
business loan or equipment loan or something like that’s in your, in the balance sheet of your,
your financials or in your books and,
(18:00)
that, that loan may have reduced over the year. So when — you can only really reduce a loan at
a profits, or if you put the money in yourself and pay it off but generally in the business sense it
will come from the profits of the business. So if I make, you know, a twenty-thousand-dollar
profit, and I paid ten thousand dollars off my, loan , with the business then I’m not gonna have
twenty thousand dollars in my bank account. I’m gonna have maybe ten thousand dollars in my
bank account and ten thousand dollars less to pay off my loan ’cause I’ve used that cash. That
cash is going out onto my loan and reduce my loan down. So that’s another area that, cash can
be absorbed and, and often, overlooked where that cash is going. One of the other areas that,
that — and this is a number but I’m just giving you the key ones to look at — the other one is the,
is if you buy plant and equipment. If you buy equipment for your business so you might spend
some of your cash on, on equipment purchases out there. So, in the business, so, so that cash,
has had — you had to pay for that out of your business. It doesn’t go into your profit and loss. It
goes on your balance sheet as an asset. So it’s not even gonna affect your profit and loss but it
will affect your balance sheet, your cash, your cash flow, and your cash bank balance. So that is
another area that, that can affect your profit and, and the reason why your cash flow or your
bank account balance is not gonna equal all your profit and loss in your financials so there’s a
lot of elements there. But the funny thing is with it, I was finally like understand why people do
get chipped out with it is because you generate money when you make profits. So if I sell
something for more than I actually buy it for, I make a profit after, you know, paying my
overheads and things,
(20:00)
well, it would be common to think that, that money goes into — goes straight into my bank
account. But it just doesn’t happen that way, generally in business because you’ve got all these
other elements playing out. Purchasing equipment, paying down loans, people not paying you
on time. , all those sorts of things can, can have an impact, on that profit, on that cash flow. So
there you have it. Now I’m getting confused myself there. There you have it, that’s cash flow
and profit and , I’ll, I’ll put some , some metrics in the show notes, some to help you calculate
those , those , numbers. The stock turn rate and the, , the debtor days. One other quick one ,
before I wrap up, is also creditors. You, when you — the time that it takes you to pay your
suppliers, , for the goods and services, the longer you can stretch those terms out, that’s
actually a positive for your cash flow because if you think about that, you’re , you’re getting the,
you’re getting the goods , and you’re, you’re incurring the — yes you should incurred the
expense but you haven’t had to — have the money go out of your bank account yet. So that’s, ,
something people often do so your customers could be even doing this to you. You need to be
careful of that but something the businesses often do is string up paying their supplies and try
and get as long to pay as possible. , so the money is in, in their bank account longer and it helps
keeps their cash flow nice and healthy and, and , you know, robust. So yes, that’s trick so the
same can work there, you can actually calculate your , creditor days or your accounts payable
days quite easily. And I put the ratio in the show notes as well. , they’ll be over on , business
made easy podcast dot com slash episode fifty two. , I’ll put it in the show note, the links in the
show notes for that. But yes, you can use those ratios and calculate
(22:00)
just how, how, how that’s, those, those, elements are working in your business. When you put
all these numbers together, you actually come out with what we call a working capital, days. , so
working capital cycles, the typical name for it and your working capital cycle is basically, all the
money going in an out of you. , how long it’s taking in terms of days in and out of your business
to, for your money to leave your bank account, turn it into goods and services and then for the
— make the sale and then for the money to come back into your business. So it’s your working
capital cycle and that’s a really important , number to get to understand as well because , when
you understand your working capital cycle, you know that if I buy that item of stock there or if
I, yes, buy that, that to sell, then that’s how long it’s gonna take me for , the working capital
days is gonna — that’s how long it’s gonna take for that money to leave my bank account, get
sold, get the product sold, get the money back in my bank account and it’s really, really good
number to know. Because when you know that, let’s just say I’ve got a working capital cycle of,
thirty days, so it takes thirty days for the money to leave my account and come back in with a,
with a profit attached to it. , then I know, when I’m doing my planning, how much money I
should have in my bank account. I really will probably wanna have about sixty days worth of, or
thirty-five at least thirty-five, sorry, want to say thirty days. I do wanna have at least forty-five
days of working capital in my bank account so that if anything popped up, I’ve got always got
cash available to, to use or, or, or to, to satisfy that emergency or that need. So you always
wanna keep above or
(24:00)
a buffer, above your working capital days and, as I say, working capital days, is an, is an easy
formula too, work out and I’ll put that in the show notes for you as well. But it’s a great way for
people ’cause people often ask,”Oh look, how much should I leave in my bank account or how
much money should I have in my business bank account?”If your, if your business is profitable
and, and your cash flow is healthy, so that means you’re collecting your payments on time.
You’re selling, you, you know, you’re turning your stock over well. You, you’re generating good
cash flow, you know? You should be out — your business, that’s, that’s when you know your
business is healthy. It’s, it’s, it’s doing what it should do at that point. , you really don’t want the
situation where you’re having to go and get into overdraft. , there are reasons why people do
need to do that. Overdrafts are good for seasonal factors sometimes and when you got a long
lead time to before you’ve got cash available but certainly, we wanna try and avoid overdraft
some loans and those sort of things if possible and keep a good healthy cash flow, ’cause it
keeps your cost down too. Banks charge money when you go into overdraft. Banks charge
money if you — if there are there to lend you money and, that sort of things, So yeah, you really
wanna make sure that you’ve got a good healthy cash flow, and, and, and looking after it. So I’ll
put those ratios in the show notes. It is a bit of technical area, I apologize. We haven’t spoken
about financials and numbers for a little while so I just thought it was time to sort of address
that one because I just had the situation again, come up the other day where someone, said,
“Oh my profit’s not the same as my cash flow.”I hope, I hope, and as I explained to, as I
explained to them, just as I have to you today, it, it very rarely will be, for that reasons that I
mentioned in this episode. As I said, it is technical, quite technical, if you’re confused, if I have
confused you, though, I do apologize, but if, if you, you have found it a bit confusing or
whatever or want further help with it, just drop me a line at
(26:00)
[email protected] and I’m more than happy to, answer any questions that
you have on today’s episode. But I hope that if you can just take away from today’s episode that
can’t — my cash flow, is going to be different from my profit, 99.9% of the time and it’s due to
the fact that, I don’t always have the money in my bank from because it’s out in — might be
sitting in the stock or might be sitting with my outstanding customers or I haven’t received the
money yet or I paid down loan. That’s usually the biggest one but I paid down some loans or, or,
or even taken dividends or even taken some money out of the bank or I’ve taken money out to
live on or, or what not. So yeah, that’s, that can be a common one as well. So there you go, thank
you so much for joining me. I hope you found this, a useful episode. I certainly enjoyed bringing
it to you, our fifty-second episode. So, here’s to a hundred and four, eh? And, I’m sure that if we,
happening on your doorstep before we know it but I hope you have a fantastic weekend
business. Thank so much for joining me and his to your success. Take us out, Mia.
Mia: Thanks, Jason. You’ve been listening to the Business Made Easy podcast, where we make
business easy.

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