Cash in: is your company really making money?

• Position: How-To GUIDE

Business owners are in business for various reasons, one of those is to make money; after all, if a business isn't making money then eventually the business closes. If you are going to be a successful entrepreneur, you will need to know if you are making money. This sounds like a simple concept, however, it is likely one of the most overlooked and least, understood concepts for new (and even long-time) business owners. So, what is the difference between cash flow and profit, and why is it important?

If you sell a product for $500 that cost you a total of $300 to produce and sell, you would have a profit of $200. The cash you get from this is pretty straightforward--assuming that cash is received at the time of the sale and cash is paid to cover the costs of producing and selling the product, you will end up with $200 cash which matches your $200 profit. However, what happens if the buyer wants 30 days to pay you? The rules of Generally Accepted Accounting Principles (GAAP) accounting state that you would still show the same $200 profit, but wouldn't have any cash to show for it for 30 days. In fact your cash flow would be $300 negative because you had to pay cash for the costs of your product. The opposite is also true--if you were paid $500 cash at the time of the sale, but didn't have to pay for any of the costs of the product for 30 days you would still show the same $200 profit, but you would have all $500 of cash for 30 days until you actually had to pay the $300 of costs.

This example provides a very simplistic version of...