Friday, May 8, 2009

Cash Does Not Equal Profit

Profit and cash are not synonymous, although many entrepreneurs, founders, business owners, and CEOs do not understand why.

The reason lies in the very format of the statement of cash flow. Cash flow is derived by taking NET INCOME for the period and adjusting it for the various non-cash and balance sheet account changes during the period. It is very uncommon that, once going through that calculation, the net income and cash flow will be the same in the same period. And if they are equal, it is almost always a matter of chance that have to do with working capital, capital expenditures, and financing activities during the period.

Why should we care? A company who runs their business purely on cash flow will make bad decisions. A company who runs their business only on net income will also make bad decisions. With both (and an accurate balance sheet), we have the tools to improve profitability and maximize cash flow. Do your competitors run their business in this way? You either need to level the playing field, or make this one component of your overall competitive advantage.