Cash flow can be a confusing concept within a business, particularly with respect to the way it differs from profitability. However, when buying or selling, it is an important aspect of a business to understand.
Cash flow is a simple concept in and of itself. It is the amount of money that a business has on hand in cash at any given time. Cash flow is money going into and out of the business through deposits and withdrawals. The balance is the money the business uses to run — to pay its costs of operation, pay its employees, pay its creditors, and pay its taxes.
Cash Flow Vs. Profit
Many people mistakenly think that cash flow and profit are the same thing. It can sometimes seem that way, but the two concepts are quite different. Profit, or net income, is revenue minus all expenses. Profit is used to determine owner distributions, future capital expenditures, and future company growth. A business can actually be profitable and not be able to pay its bills because of low cash flow. Alternatively, a business can have high cash flow and not be profitable.
Adjustments to profit may be made through controlling costs, alternate debt management, and/or adjusting consumer pricing. Adjustments to cash flow may include restructuring payment terms with both customers and suppliers. We all see “special sales” that include “limited time offers” consisting of reduced purchase financing rates, “slashed” pricing for goods, and similar “short term” offers, all of which manipulate the business’s cash flow.
Cash Flow as a Business Health Indicator
Prospective buyers of a business need to look independently at both profit and cash flow, as both are important, but not sole, indicators of the business’s overall health. They are also indicators of the past owner’s credit rating, risk tolerance, business acumen, and a wide range of other factors, that may or may not be applicable to a new owner.
If you are considering buying or selling a business, contact Larsen Law Offices, LLC, to discuss the cash flow and profits of the subject business. Experienced business attorney Susan Larsen can help you understand the complexities of these concepts and how they might affect your transaction. Call Larsen Law today at (303) 520-6030 to schedule a consultation.