Cashflow vs profit - podcast transcription

Cashflow vs profit

Greg: Welcome to Dairy News. I’m Greg Mills and today I have with me Tony Dowman. Tony, cash flow and profit, two business terms we often hear, are they the same thing?

Tony: No Greg, they are definitely not the same thing and we tend to sort of get them mixed up a little bit. We very casually talk about cash flow then mention profit and they are fundamentally different terms. We really need to understand what goes into each of the equations when we’re working out cash flow and profit.Cash flow is all about cash. It’s about money that comes into the business and money that leaves the business. So it’s looking at your cheque book for argument’s sake and saying “What cheques have I written? What cheques have I deposited?” That is cash flow.

Profit is different. Profit has a number of line items in a profit and loss statement which has nothing to do with cash. The classic one is depreciation. No one ever writes out a cheque to depreciation, but it’s something that goes into a profit and loss statement. But it does not go into cash flow reports.

Another fundamental difference is how we treat debt servicing. In a cash flow report we actually pay back the principle and the interest, where on a profit and loss report you only ever pay back the interest. The principle is never ever serviced as a line item on a profit and loss statement.

Another fundamental difference between the two is how we treat the family labour. On a profit and loss report we have a line item called imputed labour where the businesses build the cost of family labour at a given rate which may be $15 per hour or $20 per hour depending on what the farmer wants to pay, or the award wage. Whereas on a cash flow the equivalent line item on a cash flow is personal drawing. Again personal drawing is a very personal thing. Some people have very high personal drawings because they’re disposing of surplus cash where other farmers who are cash poor have very, very low personal drawings.

So you can see both reports are different. They are telling you an entirely different story about the financial affairs of the business and you should not use one or the other, both should be used to do a full financial analysis of a business.

Greg: So let’s look at the two of them separately then. So when would I be using the cash flow information about my business?

Tony: A cash flow is more current. If you want to know how you’re travelling this week, this month or this year cash flow is important to see whether you’ve got sufficient cash flow to service your financial commitments in a timely manner. Now, that timely manner might be paying your monthly feed bills or paying your annual tax requirements or paying your quarterly rate notices. So it’s all about liquidity, about have you got sufficient cash flow to meet those requirements. Where profit is a longer term picture and essentially a more accurate picture as to how the business is travelling over time.

Greg: So cash flow budgeting is another term I hear quite often. What’s the relationship there between cash flows in a budget context?

Tony: Cash flow budgeting is as I said about liquidity issues, about can I have enough cash at the end of each month to meet my cash requirements? So you have money coming in in the form of a milk cheque, stock sales and other income streams. What you need to have is sufficient money in the bank to meet the financial commitments that you have, such as paying for the feed, paying for the fertiliser, paying for contractors to come in, paying for all your overheads, electricity, all the things that you have to pay for.

If you haven’t got the cash flow to do that then you are in trouble and at the end of the day, if a business fails it will primarily fail because of liquidity or poor cash flow position.

Greg: So Tony, is there a difference between profit and profitable?

Tony: There is a big difference. Profit is the amount of dollars left over on a profit and loss statement whereas profitable is how much money is left over compared to the value of the business. The most common way of expressing profitability is return on assets or return on equity. If I said to you that I’ve got $10 left over on my profit and loss statement, have I got a profitable business? The answer is I don’t know. You need to tell me what is the value of the business?

Now if your business was worth $20 and you had $10 left over you have an extremely profitable business. But if your business was worth $2 million and you had $10 left over, you have not got a profitable business. It’s the size of the profit in relationship to the value of the business is what we call profitable.

Greg: Thank you Tony.

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