One of the main reasons that businesses go under is because of the confusion between cash and profit. Which is more important? What really keeps the business going? Well, Profit is More Important than Sales
Here’s an easy way to look at it.
Serena decides to sell lemonade outside her house at 50 pence a cup. Now if she sells a hundred of those, then she ends up with £50. However, she needs to have £10 first to use for cups, lemons, and sugar, which she thinks would be enough to make a hundred cups all in all. This means that she gets a £40 profit.
That’s not a problem if she had cash to begin with. But what if she doesn’t? She would then have to take out a loan from, which she would give back once the business starts earning money. So once she gets the £50, she can finally pay the money back, and use the £40 to start all over. She can use £10 to make 100 cups of lemonade once again. Alternatively, she could choose to aim for 200 cups this time and spend £20 as capital.
Cash versus Profit
So what does this tell us?
Profit is a sign of success and shows you that whatever you invested into the business as capital, you are finally getting back. This means that you have a lot more to invest once again, hoping to yield bigger profits this time.
But remember that thinking too much about the profits and not looking at how much cash you have could also have a huge impact. Let’s say that Serena used up all her profit to start three other lemonade stands, each stand using up £10 for capital. That covers her entire £40 profit from her first venture.
Unfortunately, a storm comes in and wrecks all four stores, including her stocks. The business is profitable, right? But because of situations that she did not foresee, she is back at square one. In short zero cash and zero stores.
This is what makes even the most profitable businesses go bankrupt. They focus too much on performance and delight in the fact that all numbers are trending upwards. They neglect to check on how liquid they actually are. So, when the time comes for additional investments to be shelled out, they end up showing nothing for it.
Importance of understanding profit
This is where the importance of understanding what profit is and what its limitations are. This way, you are able to focus not only on how you are performing based on your profits, but how your cash flow is doing as well.
If you want your business to carry on, sustain, and survive then keep an eye on your profit. Likewise, your numbers and bank balance. Profit is not the money in your bank account, even though cash is absolutely critical to pay those bills, pay yourself, pay your suppliers.
If you don’t make profit, and you focus on sales alone, say goodbye to your business, you’re going to have big problems