#001 - Understanding Cash vs Profit: A Must-Know for Professionals.

 Read time: 4 mins 

Today, we’re going to explore an important topic that often gets misunderstood or overlooked: the distinction between cash and profit.

It’s crucial for all professionals, not just department or team managers, to understand this difference as it directly impacts your ability to make informed and strategic decisions.

Revenue is vanity, profit is sanity, but Cash is King 

Profit is usually defined as the balance that remains when all of a business’s expenses are subtracted from its revenues. Cash flow refers to the net balance of cash moving into and out of a business at a specific point in time. What am I trying to say? Profit is a calculated accounting figure, cash is the liquid funds left over at the end of a particular period in time.

Having a large profit figure does not necessarily mean that a business has a large amount of cash, one of the key factors that drive this distinction is in the timing of recognizing revenue and receiving cash.

For example, if a Whitegoods wholesaler has a 90 day credit policy, it is possible that they recognize the sale of a particular good, but not receipt cash for an additional 90 days. The challenge this organization will face is working out how it will fund its operations over the 90 day period until the cash is received.

Every organization is different, however, it is possible to 'group' organizations into Industries as we see common themes in the relationship between profits and cash across manufacturing, construction, retail etc.

So what do I mean when I say “Cash is king” - the key message is that it is possible to be highly profitable and also file for bankruptcy! This does not mean that organizations should prioritize cash over profit, it means that we need to have an appreciation and an eye on both. We need to flex decision making based on the priorities of the organization at that given time - these priorities will vary. 

Why It Matters to Professionals

• Financial Stability: By understanding the difference between cash and profit, professionals can gain a clearer picture of their organization’s financial health. While profit is an important indicator of long-term success, cash is the lifeblood of any business. By monitoring cash flow, professionals can ensure they have enough funds to cover daily operations, pay employees, and invest in growth opportunities.

    a) Actionable Tip 1: If you are responsible for a financial budget, ensure you have a clear understanding of what takes priority for your organization / team at any given time. Prioritize decision making with this lens.

• Budgeting and Planning: Cash and profit differ in their timing. Profit is calculated over a period, often monthly, quarterly or annually, while cash flow measures the actual movement of cash in and out of the business. This difference is crucial for effective budgeting and planning. Professionals need to consider not only future profits but also the timing and availability of cash to meet immediate and future expenses and investment needs. You should have this front of mind when preparing your annual budget.

     b) Actionable Tip 2: With the above in mind, ask yourself what the timing differences between Cash and Profit look like within your organization and during discussions regarding future targets, ensure you make this distinction and connection to the broader organizational need. For example, while there may be a strong case to fund an upgrade of some type of plant, property or equipment, cash shortages may mean this is delayed or alternative financing arrangements are needed for the purchase to be finalized.

• Managing Operational Expenses: Understanding the difference between cash and profit helps professionals make better decisions when it comes to managing expenses. While profit might be high, cash flow can be tight due to delayed payments from customers or high levels of inventory. By monitoring both cash flow and profit, professionals can identify areas where expenses can be optimized to improve cash flow and overall financial performance.

      c) Actionable Tip 3: Get ahead, apply tips 1 and 2 and proactively suggest ways in which you believe you can assist your organization in meeting its objectives. Don’t wait to be told - a great opportunity to demonstrate strong financial acumen. Are there credit terms with a supplier you manage which could be better negotiated? Are there opportunities to speed up the time it takes for us to collect cash from the debtors of your department? Start by grasping the priority and go from there.

 Common Pitfalls

1. Neglecting Cash Flow: Many individuals, especially those without a strong financial background, tend to focus solely on profit and overlook cash flow. They mistakenly assume that high profitability automatically translates to a healthy cash position. However, this oversight can lead to cash flow problems, inadequate funds to cover operational expenses, missed growth opportunities, and even insolvency. There are many examples of this particularly within the 'tech start-up community'.
2. Improper Timing: Another reason for failure is poor timing. If professionals fail to account for the timing difference between profit and cash flow, they may make decisions based on anticipated profits without considering the availability of cash to support those decisions. This can result in overextending resources, being unable to meet financial obligations, and ultimately hindering the organization’s performance.

The Final Takeaway

There are unlimited books and resources available which will help you develop an academic understanding of Cash vs Profit - the critical element here is applying the learnings to your organization. Being proactive and providing a point of view, even by way of asking what your organization’s priorities are will certainly ensure you stand out amongst your peers. I hope you found this helpful.

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