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Can your company be profitable and not have positive cash flow?
One of the more confusing financial concepts that business owners must deal with is the difference between cash flow and net profit. The business owner may wonder how they can be making a profit without increasing their cash balance. Alternatively a business owner may experience net losses, but have a positive cash flow.
Listed below are some of the more common reasons that cash flow can be higher or lower than net profit:
- Sales on credit - when a company sells products or service on credit, the sale is generally recorded when the invoice is sent to the customer. The cash received from the customer will likely arrive in a future month.
- Deferred Revenue / Service Contracts – Certain service companies derive a portion of their revenue in the form of service contracts. For profit purposes the revenue is deferred, or spread out over the length of the service contract. The cash received for these service contracts may be on a different time table, likely billed in advance.
- Prepaid Expenses – Certain expenses are made where cash is paid, and the items expressed over the time period in which they have economic benefit. The most common example is business insurance. Typically the premiums are made at the beginning of the annual policy period and the expense is recorded each month of the period covered by the policy.
- Capital expenditures - when a company purchases large items such as machinery, vehicles or office equipment these items are recorded as fixed assets on the balance sheet. These assets do not affect net profit at the time of purchase, but cash flow is certainly affected unless they are financed.
- Depreciation expense - when capital expenditures are made, they are "written off" or depreciated over their useful life. Depreciation expense reduces net profit but has no effect on cash flow.
- Increases in assets such as receivables and inventory use cash flow as does a decrease in payables.
As you can see if one or more of these items are present, it may be difficult for the business owner plan for the future cash flow needs of the company.
An outsourced CFO can help you understand how these differences affect your business’s ability to grow. If you would like to discuss this topic in more detail please contact us.