Which Is More Important for Amazon Sellers, Cash Flow Or Profitability?
Cash flow and profit are two different indicators of a business’s financial health. Cash flow indicates the amount of money moving in and out of a business. Profit is defined as the amount of money that a company is left with after paying for all of its expenses.
Cash flow and profit are both important metrics, but investors and business owners are always looking for a singular result to guide them toward making wise financial decisions. This leads them to ask, “which is more important, profitability or cash flow?” In short, both metrics result in datasets that are crucial to informed and financially sound business decisions, but they describe very different aspects of financial health.
Cash Flow Explained
Anytime your business purchases inventory, makes a sale, refunds a customer, or pays an employee, this describes the process of cash flow. Cash flow indicates the movement of money both into and out of your business. This is one of the key differences between cash flow and profit.
While profit represents the amount of money left after you pay your business expenses, cash flow signifies the circulation and movement of money within a business. There are a few different aspects of cash flow that are important to note: cash flow position, operating cash flow, and negative and positive cash flow.
Cash Flow Position
Cash flow position is the amount of money that your business can access. Businesses keep a reserve of money that is accessible for purchasing operating space, paying employee salaries, and making inventory purchases from distributors. It may be easy to slip into the mindset of always keeping a high cash flow position, but cash flow position is a little more nuanced than that.
If keeping a strong cash flow position means sacrificing crucial business purchases, you may want to keep a lower one so that you can make purchases that are necessary to running, maintaining, and growing your business.
However, if you’re anticipating making a large business purchase such as a new piece of equipment or office space, you may want to keep a higher cash flow position to ensure that making that purchase won’t damage your company’s financial health.
Operating Cash Flow
Operating cash flow, commonly referred to as cash flow from operations, is the amount of money generated from performing regular business functions. Operating cash flow is also measured within a specific period of time (i.e. monthly, quarterly, or yearly).
Businesses with high operating cash flow are able to expand operations without sacrificing the financial health of their company. Companies with low operating cash flow tend to borrow money in order to carry out common business operations and meet financial obligations.
Operating cash flow may be a metric used to assess cash flow, but it is also a way to measure a business’s profitability. Businesses that are able to achieve a high operating cash flow tend to be more profitable, since high profit translates to more available capital.
Negative and Positive Cash Flow
The indication of negative or positive cash flow determines if a business has more money moving in or moving out of a business. If a business is spending more money than it’s making, it has negative cash flow — since more money is moving out of the business. If a business is making more money than it is spending, it’s said to have a positive cash flow status.
Indicators of Profitability
Profitability is a business’s ability, or lack thereof, to make an amount of revenue that exceeds its expenses. Profitability is an important indicator for investors to examine when deciding if they will see a significant return on investment (ROI).
Because profit does not measure the directional flow of money, there are no negative or positive profit. Profit is simply the money that a company has after it pays operational expenses, so profit is inherently a measure of gain.
Net income, also referred to as net profit, is a term used to describe a company’s revenue minus their expenses such as the cost of goods sold, travel expenses, and rent or mortgage payments on operational space, among others. Some of the expenses commonly subtracted from a company’s revenue include overhead expenses, administrative costs, income taxes, and depreciation of assets.
Gross profit is the revenue a company makes exclusively through the creation and selling of goods. To calculate gross profit, subtract the cost of goods sold (the price of materials and production) from the amount of revenue gained from the sale of the product. Gross profit is another calculation that involves the amount of money spent and gained during a specific period of time. Gross profit can be calculated short term (over the course of a few weeks or months), or long term, such as over a business quarter, a year, or even several years.
Reviewing Metrics Holistically
There are many ways to examine the financial health of a business. However, it’s important to realize that no single metric tells the whole story. Cash flow and profitability are nuanced metrics that can help indicate the direction of a business’s cash flow, how well a company is managing its operational costs, and how much money a company can dedicate to growth and expansion.
These metrics are incredibly valuable for small businesses that want to stay ahead of the curve. Every business owner should look at their finances with an honest and critical eye. But, in order to do that, you have to take a holistic approach to your business’s financial health by looking at multiple metrics.
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