Updated: Aug 29, 2019
The primary weakness of some businesses is that their owners conflate profit and cash when in fact neither of them are the same thing.
Profit is what your net revenue is - your revenue once you have deducted your expenses from it. But it’s also something that’s on paper and not necessarily something you have on hand, as they say.
Cash, on the other hand, is what you have and need all the time.
The common analogy is that profit is like food, while cash is like air. You may survive without profit for a while, but cash is essential.
A main difference between the two is that cash is what the business survives on in the short-term, while profit is necessary for the business to grow.
To put it in basic terms, an easy way to tell whether it is cash or profit depends on where the cash transactions come from and go to, as well as the accounting basis (the accounting basis determines when the transactions are recorded).
Why they should not be confused
To explain this, picture this: after the initial profits have been made, one might think about extending beyond even the original projection that one had. So what ought one do?
Your cash goes out in order for the expansion to occur. You have to buy the necessary stock or higher the right people for the job. All of this takes time, and time is money and your cash is dwindling.
What happens then? The most dangerous life stage of a business: the transition period. This is when some business owners realise that they have to overextend themselves beyond what they have initially imagined.
In this case, what one would do is to sell at a loss to raise what is needed. This could end up putting the business in a worse position than what it had started with.
This is what is called a “cash vs profit” situation.
Hence, the difference between the pair is a make-or-break situation and what their roles constitute.
Paying attention to both cash and profit - how you should do it
First of all, you need a plan with a proper strategy. Consider where you are and where you want to go as well as which steps you can take in which direction.
Envision your business and every aspect of it. Get intimate with your business. This is a very necessary part of getting your business off the ground, although it’s not enough to sustain it.
You should also have a budget. Using the budget from your income statement, you can measure your business’ past profit and project it. This will help you in determining whether the business is able to be profitable.
Through the generation of a profit and loss statement, you can determine your budget for the next half a year.
Cash and profit are not the same thing. Cash is the engine of a business and is what sustains it, while profit is what helps it grow.
With enough cash to drive your vision, you can expand at a comfortable pace to the end goal of having a profitable business.
Zarrah Morden is the Financial Minion at PAQ Group. The mission of PAQ Group is to create a stress-free bookkeeping experience and to empower entrepreneurs with financial know-how so they are able to create a more successful business. Join other entrepreneurs with the PAQ Newsletter to get regular insights on how you can grow both you and your business.