Profits and Losses
Profits and losses are the primary forces that govern the cash flow of a business. Smart business managers will keep an eye on both their profits and their losses so that they can allocate their resources effectively to ensure that they have optimised their cash flows. For some businesses, an optimised cashflow means enough money to pay expenses with a small amount of profit left over. For others, it is important to maximise profit yields to invest in the growth of the company.
To truly understand business funding, it is important to know how a business plans to make its profits. A business that earns a profit through low margins and high volume will be monitoring different aspects of their balance sheet when compared to a business that makes its profit by selling a smaller number of items at a higher mark-up. Both are valid strategies for steady cash flows, but they require different approaches to be managed effectively.
Managing expenses is a good way to increase profits without making additional sales. It can also be a way to maintain a steady cash flow while sales revenues are declining, if the sales losses are offset by a reduction in expenses. A profit and loss statement is a way for a company to review its expenses divided up into categories so that it can analyse its spending more effectively, determining which costs will have the greatest impact on its cash flow.
Production costs impact funding of a business because they represent the costs incurred with every sale. These could be expenses such as the cost of raw material or a sales commission for each item sold. The effect of production costs on cash flow can be lessened by looking to produce items more efficiently or reduce the amount spent on each item.
Fixed costs impact cash flows as a constant that remains unchanged regardless of the total number of sales. On the one hand, a business will never be profitable if it does not make enough money to meet its fixed costs. On the other hand, a company can increase its cash flow by making additional sales beyond the minimum required to meet its fixed costs.
Variable costs are difficult to account for when estimating the future cash flows of a business because they are dependent on the number of sales, and they change depending on sales volume. In some cases, variable costs could be bulk shipping fees that are eligible for a discount or pay for employees working overtime to meet customer demand. Variable costs can have unexpected effects on the funding of a business unless managers plan for them carefully.
Frequently issuing a profit and loss statement is a good way for a business to track its funding and to determine whether it is taking appropriate measures to control its costs. Understanding and addressing its production costs, fixed costs, and variable costs is vital for any business, regardless of its desired profit margin. Monthly examination of the profit and loss statement can help monitor these costs and identify expenses that can be reduced in order to stick to a profit model and maintain an optimal cash flow.