How to Track Profitability and Cash Flow

Introduction

Profitability and cash flow metrics are essential for businesses that want to make sure their operations are running smoothly and remain competitive. By tracking these two components, a business can stay aware of how efficiently their resources are being used while also having a better understanding of the on-going performance of their financials.

The benefits of tracking profitability and cash flow are both direct and indirect. By monitoring performance, businesses can identify any areas that might need improvement and/or are creating costs that can be reduced or eliminated. Plus, by having a good sense of their financials, companies can plan for future projects and investments with more confidence.

Different Terminology in Business

When tracking profitability and cash flow in a business setting, it is important to be aware of the various terms and concepts associated with both. In this section, we’ll discuss the definitions of profitability and cash flow, as well as understanding how the two are interconnected.

Definition of Profitability

Profitability is a measure of a business’ economic performance over time. It is calculated by subtracting total expenses from total revenue. Profitability is an important indicator that demonstrates how efficiently a business is operating, and is indicative of a company’s ability to generate income from its operations.

Definition of Cash Flow

Cash flow is the total amount of cash or cash-equivalents a business has available at any given time. It is important to monitor cash flow because it helps a business identify when additional funding may be needed, or if additional costs need to be cut, in order to maintain a healthy cash flow.

Understanding the Connection Between the Two

Cash flow is an important component of overall profitability, as businesses must have adequate cash reserves to cover expenses and investments in order to remain profitable. When tracking both profitability and cash flow, businesses can identify potential issues and develop meaningful strategies for improving their financial performance.

Why Should You Track Profitability and Cash Flow?

Tracking your business's profitability and cash flow are two important components of the financial management of any business. They are effective tools for objective decision-making, strategic planning, and developing effective management systems. Here are three key reasons to track your business's profitability and cash flow.

Reasons to Track

Understanding your profitability and cash flow is important for creating any meaningful business strategy. Having knowledge of these two components can be critical to making informed decisions, such as whether or not to expand, when to shift resources, and when to take on more risk. It also serves as an ongoing guide to tracking and improving performance.

Identify Causes of Unprofitable Performance

If your business is not performing as well as expected, tracking your business’s profitability and cash flow persistently can help you pin-point the underlying causes. By analyzing both your profits and cash flow, you can spot potential bottlenecks or mismanagement issues that may be resulting in lower profitability and escalating cash flow gaps.

Monitor Solvency, Cash Flow and Liquidity

By tracking your business’s profitability and cash flow, you will be able to make sure that your business is not running out of liquidity. You will be able to identify potential solvency issues, such as a sudden cash shortfall, early on and take corrective action to prevent it becoming a major issue. It will also help you monitor your cash flow performance and make sure that it is constantly up to date with its obligations.

• Tracking your profitability and cash flow gives you insight into decision-making and strategic planning.
• It can help you identify causes of unprofitable performance.
• You can use it to monitor solvency, cash flow and liquidity.

Collect Data

Profitability and cash flow tracking is important for any business. To begin tracking, businesses must first be able to effectively collect data. This can be done through accounting software, such as QuickBooks, or with an Excel spreadsheet. Business owners must ensure they are tracking the necessary data, such as income, expenses, cash flow and profitability. Additionally, data must be tracked consistently to ensure accuracy.

Analyse the Financial Information

Once the data has been collected, it is important to analyse the information. This analysis will provide a clear picture of the performance of the business. By creating easy-to-read financial reports, business owners can quickly identify areas of growth, areas of improvement and areas where more attention is needed.

Develop Strategies to Increase Profitability and Cash Flow

Once the necessary data has been collected and analysed, businesses can then start to develop strategies to increase profitability and cash flow. This could include streamlining business processes, reducing unnecessary costs, or increasing sales and marketing efforts. Additionally, it is important to keep track of the strategies and their effectiveness so that they can be adjusted if necessary.

• Streamline business processes
• Reduce unnecessary costs
• Increase sales and marketing efforts
• Monitor effectiveness of strategies

Measures To Calculate Profitability

It is crucial to track and measure the profitability of a business so a clear understanding of performance can be achieved. The following measures are widely used to calculate profitability.

Gross Profit Margin

Gross profit margin is a measure of profitability which gives insight into the sales that remain after the cost of goods sold have been subtracted. This ratio is calculated by dividing gross profit by net sales.

Operating Profit Margin

The operating profit margin is another measure of profitability where it provides a further insight by subtracting operating expenses. This ratio is calculated by dividing the operating profit by net sales.

Net Profit Margin

The net profit margin measures the overall profitability of a business. This ratio is calculated by dividing the net income by net sales. It compares the after-tax net income to the total amount of sales generated by the business.

Return on Assets

Return on assets (ROA) is a measure of profitability which expresses how much profit is generated per dollar of assets. It explains how efficiently a business operates and generates profits by using its full range of assets. This ratio can be calculated by dividing net income by average total assets.

Measures to Calculate Cash Flow

Cash flow is the net amount of cash and cash equivalents making their way into and out of a business. It is a measure of a company's liquidity, solvency and ability to generate profits. Tracking your business's cash flow is essential for assessing the financial health of your company. Here are a few measures that can be used to calculate cash flow:

Operating Cash Flow

Operating cash flow (OCF) is the amount of cash and cash equivalents generated by the core operations of a business and is used to measure its ability to generate profits. It is calculated by subtracting outflow from inflow of cash in the course of business operations. It essentially provides a gauge of a company's financial performance and a better indication of actual cash flow.

Free Cash Flow

Free cash flow (FCF) is the amount of money a business has after paying out for operating and capital expenses and paying for financial obligations. It is an important measure of liquidity and profitability, because it indicates how much cash a company has available after it pays its bills. It essentially measures how much cash a company generates from its operations.

Cash Flow to Equity

Cash flow to equity is the amount of cash that is generated from operations and is available to the company's owners after all operating expenses and taxes have been paid. It is an important measure of a company's financial performance and can help investors assess if their investment will yield a good return.

Cash Flow Coverage Ratio

The cash flow coverage ratio is a measure of a company's ability to meet its short-term debt obligations. It is calculated by dividing a company's operating cash flows by its average short-term debt obligations. It indicates the company's ability to repay its debt obligations. If the ratio is less than one, the company is unable to repay its debt obligations.

Conclusion

Tracking profitability and cash flow is a critical activity for small businesses. It is beneficial to understand the financial health of your business, in order to help optimize performance and stay ahead of potential challenges. By following the tips outlined above – developing or adapting your accounting system, setting goals and managing expenses, and monitoring key performance indicators – you can ensure you stay on top of your business’s profitability and cash flow.

Summary of Key Points

• Develop or adapt an appropriate bookkeeping system to accurately track your business’s performance.
• Calculate key performance indicators to measure and gauge overall financial performance.
• Set financial goals to track your progress and keep your business on track.
• Manage your costs and expenses to maximize profitability and cash flow.
• Continuously measure, monitor and adjust your performance based on the data you collect.

Restatement of Benefits of Tracking Profitability and Cash Flow.

By staying on top of profitability and cash flow, small business owners can ensure they have access to key data to make informed decisions, effectively manage their costs and expenses, optimize performance, and anticipate potential challenges.