Preparing Financial Forecasts: Cash or Profit?

As accountancy and finance professionals, our primary goal is to provide the most accurate financial picture for our clients and leadership teams. One critical area where this accuracy is paramount is in financial forecasting. We know that while profit and loss (P&L) forecasting is often the go-to method, it can present a misleading picture if cash flow isn’t considered alongside it. To truly understand a business’s financial health, both profit and cash must be factored into the equation.

This article aims to help finance professionals illustrate this difference to their stakeholders and suggests how using an integrated cloud based three-way forecasting tool and finance forecasting software can speed up the process and ensure that accuracy is paramount.

Understanding Profit and Cash

To lay the foundation, it’s crucial for stakeholders to understand the difference between profit and cash. Profit represents the financial gain a business achieves when its revenue exceeds expenses over a given period. Cash, on the other hand, refers to the actual money available in the business at any given moment, including bank balances and physical cash. While these concepts may seem straightforward, many business owners and leadership teams often overlook their distinct implications, which can lead to financial blind spots.

Timing is also a key factor in differentiating profit and cash. Profit is recorded when income is earned and expenses are incurred, as per accrual accounting principles. In contrast, cash flow reflects the money received and paid out, adhering to cash accounting methods. This disparity in timing means that a business can appear profitable on paper while struggling to meet immediate financial obligations due to cash shortages.

An added complexity arises when the finance professional receives the information regarding profit and cash separately, at different times, and from different people in the organisation. Confusion and inaccuracies can occur when accountants and finance professionals have to review multiple spreadsheets in varying formats. Checking each formula and manually uploading the data separately into one spreadsheet is time consuming and prone to error.

The Importance of Liquidity

Liquidity, the ability to meet short-term obligations, is a critical consideration for any business. A company may show profitability in its accounts but still face significant challenges if its cash reserves are insufficient. Positive cash flow ensures that suppliers, employees, and other operating costs can be paid on time, keeping operations running smoothly and preventing unnecessary financial stress.

Balancing Sustainability with Profit and Cash

The relationship between profit and cash flow becomes even more apparent when considering business sustainability. Profitability is essential for long-term growth and investment, enabling businesses to reinvest and expand. Meanwhile, maintaining a positive cash flow is vital for day-to-day operations, ensuring the business avoids insolvency and can adapt to unexpected challenges. By focusing on both profit and cash flow, businesses can achieve financial stability and make informed decisions about growth, cost control, and financing.

A Practical Example: The Bakery Dilemma

To illustrate this point, imagine a small bakery that operates on both cash and credit sales. In January, the bakery sells £10,000 worth of cakes to local cafes on credit, with payment due in 30 days, and £2,000 in cash to walk-in customers. During the same period, the bakery incurs £8,000 in expenses for ingredients, rent, and wages. On paper, the bakery shows a £4,000 profit, but in reality, it only received £2,000 in cash. This leaves a cash shortfall of £6,000, creating immediate challenges in meeting financial obligations like rent and wages. This example highlights the necessity of monitoring cash flow alongside profit to avoid disruptions.

This example may be useful to share with your clients or stakeholders.

The Role of Advanced Forecasting Tools

Accurate financial forecasting requires tools that integrate various financial metrics seamlessly. Clearview’s cashflow forecasting tool is an excellent example, combining profit and loss, cash flow, and balance sheet projections into one platform. This approach eliminates the need to juggle multiple spreadsheets and manually check formulas, saving accountants and finance professionals significant time and effort. Tools like Clearview’s cash flow forecast software not only simplify the process but also enhance forecasting accuracy, providing a comprehensive view of financial health.

Why Accurate Forecasting Matters

By preparing forecasts that consider both cash and profit, accountants, business advisors and finance professionals can provide a more holistic view of a business’s financial position. This dual approach helps businesses maintain financial stability, make informed decisions, and avoid potential pitfalls like cash shortages that can derail operations despite high profitability. It also plays a critical role in securing investment or loans, as investors and lenders often scrutinize both profitability and cash flow before making commitments.

Take Control of Your Forecasting

If you’re looking to improve your forecasting, Clearview offers a free, integrated cashflow forecasting tool designed to streamline the process. Whether you’re an accountant, business advisor, a finance director, or a business owner, our solution can transform the way you approach financial projections. Say goodbye to the complexities of spreadsheets and embrace a more accurate, time-efficient method with Clearview. Try our business finance planning solution today and experience the benefits of advanced financial projection software firsthand.