Is a profitable business necessarily a prosperous one? | SSON Analytics

Are you mistakenly conflating profit and cash flow?

Financial terminology is used almost universally to provide numerical information on various aspects of a business – from profitability, health to direction. One of the most popular metrics used to decide whether an investment should be undertaken is the Return on Investment (ROI). In simplest terms, ROI measures the gain or loss generated on an investment relative to the investment’s cost and is calculated as a benefit over cost percentage. Much as ROI provides a reasonable frame of reference or decision-making process, its inherent limitation is in its oversimplification.

 

The one mistake that many business owners make is to confuse cash flow and profit. It is entirely possible for a profitable business to go bankrupt, and this is because cash flow and profit are two terms that represent different financial parameters. Profit appears on the balance sheet and reflects the surplus after total expenses are deducted from total revenue. It looks only at income and expenses at specific points in time. In contrast, cash transactions show on the cash flow statement and reflect the amount of available cash currently on hand as a result of inflow and outflow of money. Cash is more dynamic as it takes into account the movement of capital and is, in truth, more aligned with reality.

 

So why is it possible for a profitable business to go bankrupt? Business is profitable so long as the product sells for a higher price than its cost of production. This does not take into account delays in invoice payments. In the (highly possible) event that material suppliers demand payment before customers pay their invoices, the business would be plunged into a negative cash balance and, in the worst-case scenario, possible bankruptcy. Conversely, a company could be pumping in more money to maintain a positive cash flow even if per-unit cost has exceeded break-even point and the business is no longer profitable. Since cash is imperative to daily operations, meeting payroll, purchasing inventory, and other short-term financial obligations, it is arguably more prudent to use cash as the key indicator of business health, rather than profits.

 

To check how your organisation match up with others in the same industry, you can use SSON Analytics’ proprietary Metric Intelligence Hub™. This first-of-a-kind benchmarking tool houses country and industry-specific benchmarking datasets generated in-house using a productivity efficiency benchmark model (CICI-PEB) which is unique and proprietary to SSON Analytics. You can filter by country and by industry to access accurate, proven benchmarking metric data across individual metrics. Some useful metrics to check with regards to your cash flow are Days Sales Outstanding, Number of Business Days to Resolve an Invoice Dispute Case, Ticket and Paid On-Time Rate.

Figure 1: Days Sales Outstanding for the Banking, Financial Services & Insurance industry in the United States. Find more metrics on our Metric Intelligence Hub™

 

When placed in this perspective, it seems that the financially enlightened thing to do is to take a hard look at all balance sheet items and reevaluate them as cash transactions. This method of calculating ROI would indeed prove valuable in aligning projections with reality more closely and enable your business to be not only profitable, but also prosperous.

Tags:


SSON Salary Index Banner

User Area

Blog Archive

November 2018

October 2018

September 2018

August 2018

July 2018

June 2018

May 2018

March 2018

February 2018

January 2018

December 2017

November 2017

October 2017

September 2017

August 2017

May 2017

April 2017

February 2017

January 2017

December 2016

November 2016

October 2016

September 2016

August 2016

July 2016

June 2016

May 2016

April 2016

March 2016

Media Relations

For media enquiries relating to SSON Analytics or any of our data, please contact Sian Jenkins.

Email: info@dart-institute.com

Tel: +65 6722 9361

Most Commented Blogs

  • Most Commented Blogs
  • Past:
  • 1 day
  • 1 week
  • 1 month
  • 1 year