Cash, Profits, or Profitability?
By: Ruth King
Operating your business on cash is insane. Operating your business on profits is ok. Operating your business on profitability is best.
When you operate your business on cash you have no clue if you are profitable or not. You only care if you have cash in the bank to pay your bills. As long as you are growing, even if you are not profitable, you will have the cash.
I often tell the story of a business owner who started a business and grew it to $2 million just paying attention to cash. When the company hit $2 million in revenues growth stopped and the problems began. Soon he couldn’t take his discounts and sometime had a problem paying payroll. To make a long story short, he was smart enough to call me. My analysis showed he was losing a nickel for ever dollar he took in the door! This went on for 12 years.
Because it was “just a nickel” the cash flow masked the problem since cash increased as the company grew. Since they never paid attention to profits and profitability they never knew the company was unprofitable. When growth stopped the lack of profits was exposed: lack of proper cash flow.
Ok. What’s wrong with operating your business on profit? Actually, nothing.
Operating on profit is a short term view. If you have profit one month you may or may not have a profit the second month. And, you don’t know whether your profits are increasing on a long term basis since you are focused solely on the month to month profit. You might get really concerned with a loss one month and forget about the following month because the company was profitable. Yo-yo profit and loss can be a recipe for disaster.
The best focus? Profitability.
Profitability is sustained profits. It is the ability to always fund operations through the profits of your company. A month’s loss is concerning and the reasons for the loss need to be determined. However, if the company has increasing profitability, the one month loss will not kill the company.
The best way to determine if your company has increasing profitability is to calculate the company’s current ratio: current assets divided by current liabilities. As long as you have categorized all of the assets and liabilities correctly, an increasing current ratio from month to month means increasing profitability. The only exception to this rule is extraordinary events such as a huge tax payment, purchasing or selling a vehicle, etc. or PPP loans that you obtained and got forgiven.
Focus on profitability, then profits, and then as long as you collect your money, you will have enough cash to run operations.
Ruth King is known globally as the “Profitability Master,” and is a a thought leader in entrepreneurship and business. Her books have been recognized as among the greatest in numerous industries. Learn more about all her business activities here.