There are a lot of ways to measure success in business. Small business owners do what they do because it gives them freedom, or because they’re passionate about their services, or even because they love the idea of building something all their own.
If you’re achieving any of that, you’re doing good.
But when it comes to maintaining a small business, there’s really only one metric that matters—financial performance. And it turns out financial performance is a tough goal to hit. (Maybe that’s why 20% of small businesses don’t even make it a year.)
If you want to ensure your company’s success, you’ve got to have a solid understanding of cash flow versus profit.
In this article, we’ll take a look at the key differences and run through a few tips to help keep you on top of both. Discover how you can quickly and easily monitor cash flow and profitability to gain real insight into how your business is doing.
What is profitability?
Profit is the income you receive after all expenses have been deducted. If running your business costs $50,000 per year and you collected $100,000 during that same year, you made $50,000.
Profit is generally considered the primary goal of business. Basically, you want to make money.
But profitability isn’t the only issue. Cash flow matters, too.
What is cash flow?
The phrase “cash flow” describes the money that flows into and out of your business. You have positive cash flow if you have more money coming in than going out. You have negative cash flow if you’re spending more than you have coming in.
Cash flow matters because it’s the money you use in real-time to keep your business running.
For example, positive cash flow means you have money in the bank to pay your utility bills and rent. It gives you the means to make repairs when needed. Or if you have to order something unexpectedly, positive cash flow means you can.
How can you have one without the other?
It’s possible for a business to be profitable with negative cash flow. Similarly, it’s possible to have positive cash flow and lose money.
Cash flow is typically calculated month-to-month. That’s why it’s so closely related to recurring business expenses. It gives you an idea if you have the resources you need to keep your business running.
In contrast, profitability is the long game. You don’t calculate profit based on what happens each month, but based on how your business performs in the long term.
So, consider this example. You bill customers with a 60-day term. After receiving their invoice, they have 60 days to pay. If you bill 20 customers in May, but none of them pay that month or the next month, you could have negative cash flow for May and June, but amazing cash flow in July when all those invoices get paid.
Did you turn a profit for the same period? Maybe. Or maybe your expenses outpaced your income. It could go either way.
Because cash flow is a month-to-month thing, some months your cash flow will be good and some it may be bad. You need cash flow to sustain a business day-to-day. You need profitability to stay in business year-to-year.
Here’s how you can make sure both your cash flow and your profitability are healthy.
(Note: There’s some overlap in these tips. That’s because the concepts are related and dependent. But it’s important to understand how and why they’re different, too. You can’t afford to overlook either cash flow or profitability.)
5 Tips for monitoring cash flow
Find your break-even point
You can’t effectively monitor your cash flow until you know exactly what you are dealing with.
When you are investing in your business—everything from a new hire to opening a new location—you need to know how much you can afford to increase your costs per month. So, you need to know what your break-even point is.
How much can you afford to spend before you slip into negative cash flow?
Focus on receivables due
Make sure invoices are paid on time.
You can help that process by sending invoices promptly and making sure your invoices are clear, easy to understand, and include all the most important info.
If you aren’t sure if your invoices are everything they should be, check out our guide on how to write an invoice.
Offer discounts or gift cards to clients who pay what is owed before the due date.
Does that mean less per transaction? Yes. But it also means you’ll have more cash on hand. Anything you’re owed that you haven’t received yet hurts your cash flow. This will help.
You likely wear several hats as a small business owner. You really don’t need another task.
Is there anyone else you trust who can take on cash flow monitoring for you? If so, delegate, delegate, delegate. That frees up some of your time and gives you the opportunity to train one of your staff in a critical role.
Keep an eye on seasonal trends
Take a look at your calendar and identify the big sellers across the seasons. Push these at the right time for a cash flow boost.
5 tips for maintaining profitability
Keep track of profit margin
Profit margin is calculated by dividing gross sales by your net profit.
Determine your profit margin and then take a look at the average profit margin for your industry. That way you have a gauge for how well you should be performing.
If your profit margin is low in comparison, that’s a red flag. Start taking action now to boost it. We suggest beginning by taking a close look at your expenses and your fees. Can you cut costs without sacrificing quality? Are you charging as much as the competition?
Sometimes a series of relatively small changes are enough to dramatically improve profit margin.
Hone in on ROE
ROE stands for “return on equity.” It’s different from ROI, or “return on investment.” ROI reflects performance. ROE, however, indicates your future potential profitability.
If you’re not sure how to calculate ROE, use this calculator.
This number is important because it will help you compare your profitability to the competition. It will also give you an idea of what kind of opportunity you have for boosting profit—an important thing to consider before making additional investments.
Streamline your entire operation
How quickly are you able to fulfill customer orders? Are there any unnecessary steps you can remove?
We suggest using a tool like Lucidchart to create a visual representation of your core processes. When you see everything mapped out, it becomes much easier to spot weak, inefficient points. Once you know where the bottlenecks are, you can start taking steps to address them.
If you can eliminate inefficiency, your profitability will go up.
Don’t forget to upsell
When your customers make a purchase, are there additional goods or services that might pair well with it? Sometimes it’s as simple as making a suggestion—and boom, your profitability just went up.
A lot of small business owners miss out on upsell opportunities because they require proactive salesmanship. But you don’t have to be a master salesperson to upsell. You just have to see the opportunity and take it.
Train your staff to upsell, too. You might even consider recognizing (or monetarily rewarding) staff members who successfully upsell.
Focus on retention
By offering the best quality support and after-sale care, you can turn one-off customers into loyal clients. It’s much cheaper to retain an existing customer than to recruit a new one, so make sure your customers know you care.
The simple act of making every customer feel cared for is enough, all by itself, to substantially boost profits. And you can start today.
Say thank you. Train your staff to say thank you. Make sure your customers know you sincerely appreciate their business—every single time.
Recognize the difference between cash flow and profit, but don’t stop there. Take steps now to manage both. That’s the only way to ensure your business’s success.
The tips in this article will help you secure growth in both the short and long term.