Cash flow is the difference between the amount of cash a company receives and pays, whereas profitability is the difference between revenues and expenses and every company report on both their cash holdings and profitability as part of its financial reporting. Certain cash flows cannot be recorded as revenues or expenses at the time of the transactions, while other cash flows may not be part of the operating activities, and thus are not profit related.
Concept of Profitability in Business
The success of a small business depends on its ability to continually earn profits. Profit basically equals a company’s revenues minus expenses and is critical for businesses because it determines whether a company can secure external financing, attract more investors or grow its operations. A business owner must understand the importance of profitability in business management and develop strategies that give his company the best chance at remaining profitable as that is its main goal for existence among other goals.
Relevance of Profitability in Business
Profits stimulate investment and innovation and as a business undertakes more investment, it leads to generation of more employment. With generation of employment income, more demand for goods in the market will be created.
Profit is regarded necessary for business survival and growth and a business that does not make enough profit is not likely to survive in a growing competitive environment because it enables the business to grow, motivate employee, attracts investors etc.
Profit is a return on investment and every firm invest money with the expectation of higher returns on their investment. Just like shareholders expect higher returns in the form of dividend so do financial institutions expect better rate of interest on the loan given to the business enterprise.
Profit is used test the efficiency of a business and the success or otherwise of the business can be judged by the extent of profit earning capacity.
Profit serves as buffer to meet unexpected expenditures and as a business is exposed to many risk and uncertainties including changing market demands and conditions etc., profit is used to meet such unfavorable business changes.
Retained profit serves as a form of internal financing and can be used for increasing the volume of business through expansion and diversification. Any further surplus is re-invested in the business for further development.
The Concept of Cashflow
The old-age saying, “cash is king” which is usually used to explain the failure of both businesses and consumer households remains relevant in modern business because without proper amount of cash on hand, entities can run into major trouble, and even be forced into bankruptcy. Cash inflow is the lifeblood of every business and businesses need cash for various reasons including investing in new infrastructure and dealing with unexpected expenses. Moreover, a key factor in a business’s potential for long-term success is cashflow and as such a company may have all the revenue in the world, but without the ability to generate cash, it can easily fail. Without cash a business won’t run, resulting in employees becoming cranky and suppliers ceasing to supply materials even though the business may be very profitable. Sources of cashflow include receipts from customers, additions to capital, payments to suppliers etc.