Mastering Money Management: A Guide for Small Business Owners

As a CPA with more than two decades of experience, I’ve worked with countless small business owners and have had a front-row seat to the financial pressures you face every day. Juggling multiple roles while trying to keep your business financially healthy can be overwhelming, especially when you're bombarded with a myriad of financial metrics that you don’t know how to interpret.

In my experience, three key metrics provide the foundation for your financial reporting: revenue, profit, and cash flow. Too many passionate entrepreneurs struggle to keep their businesses afloat, not because they lack dedication but because they failed to prioritize these key metrics effectively. 

While they go hand in hand in many ways, there are critical differences every business owner needs to understand about these metrics and why they matter. Let's break down the fundamentals.

Three Key Financial Metrics: Revenue, Profit, and Cash Flow

Revenue

Revenue is sometimes referred to as the "top line" of any business. Generally speaking, revenue refers to all money that comes into the business. It's the top line of your income statement and represents the starting point for all financial discussions. However, revenue alone doesn’t tell the full story of how your business is performing because it doesn’t take into account the money that is going out to cover expenses. 

While high revenue is often perceived as a marker of success, it's essential to recognize that revenue alone doesn't paint the full picture of your business's financial well-being. Instead, it’s the foundation upon which you can assess your profitability and cash flow. That being said, it’s helpful to think of revenue as a measure of the volume of your business, a reflection of how much you are selling.

Profit

Every entrepreneur is in business to make money and the indicator for successfully achieving that is called Profit. While revenue represents the money that is coming in (i.e. sales), expenses are the funds you spend to run the business (money going out). The goal is to bring in more money than you spend, which results in a Profit. Conversely, if you were to spend more money than you brought in, you would be operating at a Loss.

There are several types of profit, each offering unique insights into your business's performance:

• Gross Profit: Revenue minus the cost of goods sold

• Operating Profit: Gross profit minus operating expenses

• Net Profit: The bottom line after accounting for all expenses, including taxes and interest

Profit is the “extra” money in the business that you, as an owner, can take out as earnings or, alternatively, reinvest in your business to grow it further. It’s also a more realistic representation of how much money is available within the business because it’s already accounting for the money that’s required to operate. 

Understanding the overall profit of the organization is important for this reason, but the profit per product/service line is even more impactful. This will show you the profit for each of your business offerings which can be valuable information in determining where you should focus your efforts.

Cash Flow

Cash flow is the movement of money in and out of your business. Positive cash flow occurs when you have more money coming in than going out, while negative cash flow indicates the opposite. Think of negative cash flow as an overdraft for your business, which is obviously not ideal. Every business owner should be closely monitoring their cash flow to understand how much tangible money is available, but unfortunately, many don’t. Having a positive cash flow is an indicator of a healthy business, which is essential for sustaining operations, fueling growth, and weathering unforeseen difficult times for the business.

Even profitable businesses can struggle with cash flow if they mismanage the timing of cash inflows and outflows. There are several causes that can lead to poor cash flow management, like inaccurate forecasting, late or missed payments, underestimating expenses, or poor inventory management. These challenges don’t just hurt your financial health, but they can take a toll on your mental health, too. 

Understanding the Interplay Between Revenue, Profit, and Cash Flow

The relationship between revenue, profit, and cash flow is intricate and dynamic. Each of these financial metrics plays a unique role in your business's overall financial health, and they are all interconnected. Here’s how they work together:

How Revenue Impacts Cash Flow

We often talk about financial goals for entrepreneurs in terms of money earned. Revenue is a vital component of cash flow, but it doesn't always translate into immediate cash in hand. And earned money is not necessarily real. The amount that you asked for on an invoice may not always be paid for a variety of reasons. The project might fall through, scope of work might change, or worst case, the client just outright refuses to pay. This can impact business owners who have been making future plans based on unexpected income that won't be received. 

For example, let’s say you offer 30-day payment terms. That means while you may record a sale as revenue on day one, you won't actually receive the cash until 30 days later. During this time, you still need to cover your own expenses, such as paying 1099 contractors or covering expenses for your home office or vehicle.

This timing discrepancy between revenue and cash collection can create cash flow challenges, especially for businesses with long payment cycles or seasonal sales fluctuations. For example, at Little Fish Accounting, our clients pay in full at the beginning of the year which means we have a huge influx of cash in the first quarter. And we have to make that money stretch until we start taking on new clients which isn’t until after tax season. 

Managing this timing discrepancy is critical for maintaining healthy cash flow. Cash flow is the top reason for small business shutdowns, and it's hard to plan to ensure you can pay business expenses when you don't have a clear understanding of what's coming.

The Relationship Between Profitability and Cash Flow

Profitability is a key driver of cash flow,  as generating profits means you have more money available to reinvest in your business. However, it's not the sole determinant, and profitability alone doesn't guarantee a strong cash flow.

A business can be profitable on paper but struggle with liquidity if cash is tied up in inventory or accounts receivable. On the other hand, a business with low profitability can still maintain a strong cash flow if it manages its expenses and collections efficiently. 

Balancing Cash Flow and Growth

Reinvesting profits into your business is essential for growing your business. However, it can create a temporary strain on your cash flow as you allocate funds towards new initiatives, such as hiring 1099 contractors or purchasing equipment.

To sustain long-term growth without jeopardizing your cash flow, it's important to strike a balance between reinvestment and maintaining sufficient cash reserves. This may involve:

• Developing a clear growth strategy with prioritized initiatives and timelines

• Setting aside a portion of profits in an emergency fund

• Phasing growth initiatives over time based on your seasonality to manage cash flow impact

By understanding the interplay between revenue, profit, and cash flow, you can make more informed financial decisions that support your business's short-term stability and long-term growth objectives.

6 Strategies for Effective Cash Flow Management

Let’s face it: Managing cash flow can make or break your business. Here are six recommendations we make to our clients:

1. Regular Cash Flow Monitoring

First, regardless of the type of business you run, you’ve got to implement regular cash flow monitoring. This means setting up tracking systems and keeping tabs on your cash flow in real time. This isn’t a task you can do once a month; we recommend at least a weekly check-in. By doing this, you’ll be able to spot any trends or identify upcoming issues before they snowball into larger problems.

2. Streamline Your Accounts Receivable Management:

Those are fancy words, but here’s what they mean: You need to figure out how to get your cash faster. Shorten your payment terms, offer incentives for early payments, or automate your invoicing and payment follow-ups with clients. Not only will this save you time in the long-run, but it can also help you get your hard-earned money in the bank faster. After all, is that every entrepreneur’s dream?

3. Optimize Your Inventory Management

Now, this might not apply to every small business owner or be the most exciting topic, but optimizing your inventory can do wonders for your cash flow. If you’re a product-based business, you need to conduct regular inventory check-ins to identify any slow-moving or obsolete stock. Don't be afraid to liquidate or reduce excess inventory levels. Implementing just-in-time inventory practices can also help minimize holding costs and keep your cash flow efficient.

4. Negotiate Favorable Payment Terms

Don't be shy about asking for extended payment terms with certain suppliers or companies you work with, especially if you’ve built relationship equity with them. Always look for opportunities to consolidate your purchasing. If you're facing immediate cash flow pressures, you can also ask about alternative payment arrangements like vendor financing.

5. Get a Handle on Your Operating Expenses

Basically, you want to look for ways to spend less money. Take a close look at your operating expenses regularly to identify any areas where you can save money or eliminate expenses altogether. Can you negotiate a contract? Is it possible to cancel the monthly subscription you no longer use? Don't be afraid to outsource non-core functions to lower-cost providers to reduce overhead expenses. Every dollar counts and eliminating several of what seem to be “small” expenses can add up to a significant amount of savings quickly.

6. Utilize Financing Options

Even the best financial planners might still run into a time when they need to secure a line of credit to cover short-term cash flow gaps or finance a growth opportunity. You’ll want to investigate all your options and be open to exploring alternative financing options than traditional lenders. You need to keep your personal risk tolerance in mind and have a clear game plan for paying off your debt. 

The bottom line? Getting clear on your finances requires a commitment, but the peace of mind and control it brings to your life as a small business owner are truly priceless. Revenue, profit, and cash flow all play a vital role in the financial health of your small business, and understanding how they interact is crucial. Proactive cash flow management is key, but it doesn’t happen overnight. By following the practices outlined above, you can make progress to building a business you love. 

Disclaimer: The information on this website is not intended to provide, and should not be relied on, for tax advice.

Get so much more for free

Found is the ultimate business bank account, with built-in bookkeeping and tax tools.

Get started