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Cash Flow is King: The Difference Between Profit and Cash Flow

It’s easy for small and medium sized businesses to get hung up on making a profit, but cash flow is even more important than profit, and the two are quite different things.  A business can make a profit but still have poor cash flow, and vice versa.  Businesses do not necessarily fail because they don’t make a profit, but more often just because they run out of cash. 

What is Cash Flow?

So what is the difference? While profit is the amount of money left when expenses are deducted from invoiced sales, cash flow is about the actual monies received and monies paid out, and whether there is always enough in the pot to be able to pay bills today, next week and beyond.

So making sure the business has enough money to pay for all its expenses as they fall due is vital to staying in business.  It’s simply not enough to be turning a profit – there needs to be enough cash, or access to borrowed cash, in the business to consistently sustain it. This requires careful planning and monitoring of cash flow.

You not only need to know what’s in the bank account right now, but what cash will be received when and what expenses are due for payment in the future.  A crystal ball might be useful here.

Why is Cash Flow Important?

What about any unexpected costs that may arise? Say a customer does not pay an invoice on time? Can the business cope without the cash that would have been received had the customer paid his invoice on time? 

Cash held in the bank account is extremely useful but whilst it’s sitting there the cash is not working very hard.  This is why many businesses invest their cash into stock or work in progress rather than leaving cash in the bank account.  

So what happens when the bills need paying and there is insufficient cash in the business’s bank account?  A common fall back is the good old fashioned overdraft provided the bank.  Overdrafts are designed to assist with immediate and short term cash needs and overdrafts are invaluable to most businesses.  All but very large businesses tend to only run one banking relationship at a time and therefore that relationship between the business and the bank is very important to both parties.

So what happens when cash needs exceed the business’s agreed overdraft facility? Like all relationships you will only know how strong the relationship is when the relationship is tested.  Some businesses prefer not to test their relationship with the bank. So why rely solely on the bank for finance?  Some might say it’s like putting all your eggs in one basket.

Who Should You Turn To For Asset Finance?

From time to time businesses acquire machinery, IT or vehicles and the question is: How best to pay for them? In our opinion using bank funding is short sighted.

Should a business decide to use its valuable but limited bank facilities, be they overdraft, bank loan, or asset finance via the bank owned finance company, there is a significant risk that should the business later ask the bank for further help it will either say, “No, sorry we can’t help”, or ask for further security in the form of personal guarantees or charges over your home or business as a condition of any lending.  Remember that every bank has a ceiling on the level of overall lending it feels comfortable to lend to your business at any time, so why clog it up with assets which could easily be financed elsewhere?

So it pays to think not only about the cost of any finance, but also who could best be the provider. 

Most bank overdrafts and bank loans can be “called in” at very short notice, whereas a finance company which has provided Hire Purchase or Leasing contracts cannot do that. This means your valuable banking relationship remains intact and hopefully ample lending head room remains with the bank for that rainy day. 

By using Hire Purchase or Leasing provided by an independent finance company such as Arkle, the business knows the interest rate charged is unlikely to increase during the term of the finance agreement, and the repayments will be fixed.  This means your business can better predict its cash flow for the term of the finance which could be up to 7 years.  Using Hire Purchase or Leasing is a great budgeting and cash flow protection which helps preserve that special relationship with your bank, for more critical matters.

Being able to forecast your cash flow more accurately means you can make important decisions about the future of businesses, and good cash flow management can prove be the difference between success and failure.

If one of your likely expenses is equipment, such as machinery, IT equipment or vehicles, then Arkle Finance may well be able to help you. Contact us to find out more from our friendly, expert team on 01933 304789.

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