In this article I will illustrate the effect profitability has on cash flow.  (And note, in this article I have now appropriately changed the name of the company to “Larry’s Survival Strategies, Inc.”)

In this scenario, I assumed that Larry has very little control over sales, so he needed to control expenses instead, and mainly, Payroll Expenses (and presumably, HIS).  Click HERE for a comparison of his original P&L, with a Pro forma of what it would look like by holding down payroll so as to target a Net Profit of about $15,000 (i.e., 15% of sales):

The Pro forma Cash Flow Statement now reflects the impact of  the company’s profit, in addition to the improvement in turnover ratios, on its cash position.  Note that by eliminating the cash drain created by the loss and producing a small a small profit, the company’s cash flow increased $117,000 (rounding) from a negative $232,000, to a negative $115,000, thus leaving a positive balance of nearly $104,000 in its operating account.

So the short answer to the question as to which is more important, profit, or cash flow, is BOTH.   However, “profit” is a criticalcomponent of cash flow that is required for the long-term survival of your business. For this particular company, even though the owner paid himself back over $175,000, if the business had been profitable, there was still sufficient cash in the business to allow him to do that.  So the most important thing was to stop (prevent) the “bleeding” due to the operating losses, as that is the most difficult cash flow issue to fix. And unchecked operating losses will, over time, drain all of the company’s cash, so that eventually, it will no longer be able to operate.

And once again, in order to know if your business is profitable, you need to maintain your books on the accrual basis of accounting.  If your books are maintained on a cash basis, you are only seeing the symptoms of your cash flow issues, not the true underlying causes, so you won’t know what needs to be fixed (or, is working well, as the case may be).

About the Author(s)

Jack Kern

As a prior financial officer with private, fast growing businesses, Jack makes available to clients a level of sophistication in accounting and corporate finance that is usually found only in larger companies, but at rates affordable to smaller businesses.

CFO / Controller, Financial Planning and Analysis (FP&A) Manager, Outsourced Accounting Department, Inc.
Cash Flow