Profit and Liquidity - How do you explain to the shop owner that profit does not mean liquidity?

Aug 16
4 min read

Updated: 2 days ago

Profit and Liquidity - How do you explain to the shop owner that profit does not mean liquidity?

Introduction

Many small and medium shop owners feel confused when they find at the end of the month that their profits on paper look good, but their bank accounts are almost empty or their cash flow is weak. This is where the common confusion occurs between... Profit Cash liquidity Some people think that making a profit necessarily means having money available in hand or in a bank account, and this is not always true.

In this article we will explain:

The difference between profit and cash flow.
Reasons for having profit without liquidity.
How to deliver the information to the shop owner in a simple manner.
Practical steps to improve liquidity despite achieving profit.
Real-life examples help solidify understanding.

First: What is the difference between profit and liquidity?

1. Profit

Profit is The difference between revenues and expenses During a specified period of time. It is calculated through financial reports, and may be:

Net profit: After deducting all costs, taxes and expenses.
Gross profit: After deducting the cost of goods only, excluding operating expenses.

Example: If you sold goods worth 50,000 riyals and they cost 30,000 riyals, the total profit = 20,000 riyals.

2. Cash Flow

Liquidity is Money physically available in a bank account or safe, which can be used immediately to pay off obligations or invest.

You may have high profits on paper, but if your customers don't pay you or your money is stuck in inventory, you won't feel those profits in liquid form.

Second: Why might there be profit without liquidity?

1. Sales on credit

If you sell products to customers but they have not yet paid (customer debt), your accountant will record these sales as revenue, but they have not yet turned into real money in your hand.

2. Inventory accumulation

Purchasing a large amount of goods consumes cash, even if these goods will be sold later.

3. Deferred payment obligations

You may be recording an expense in the report, but not actually paying it yet, giving a distorted picture of your financial situation.

4. Internal investments

Reinvesting profits in improving the store or purchasing new equipment reduces available liquidity, even though the profit in reports may appear high.

5. Financial distributions

Withdrawing a portion of the profits or distributing them to partners reduces liquidity, even if the annual profit is high.

Third: How do you communicate the idea to the shop owner?

It is important to explain the matter in a way that is far from accounting complexity, and it is preferable to use real examples from its activity.

1. Simulation of a person’s life

You can say: “Imagine that you receive a monthly salary of 10,000 riyals, but you buy a new car in installments and pay a large down payment, or you buy new furniture. You will find your account almost empty even though your salary has not changed... The same thing happens in the store.”

2. Use examples of his wares

“This month I sold goods for 50,000 riyals, but 20,000 of them were on credit, and I spent 10,000 on a new order, and 5,000 on maintenance. The rest in your pocket is cash, not the 50,000.”

3. Display the difference on a piece of paper or a board

Prepare a simple table in it:

Revenue
Expenses
Profit
Available cash

Fourth: Practical steps to improve liquidity with profit

1. Follow up on collection

Establish a clear policy for collecting dues.
Offer small discounts to those who pay early.
Avoid excessive forward selling.

2. Inventory control

Don't buy more than you need.
Rely on actual demand rather than exaggerated expectations.

3. Expense management

Monitor monthly expenses carefully.
Eliminate unnecessary or deferred expenses.

4. Separating profit and liquidity

Designate a separate bank account for savings.
Do not rely on accounting profit in exchange decisions.

5. Preparing cash flow reports

Use Google Sheets or accounting software to view liquidity movement.
Monitor the spread between cash and forward sales.

Fifth: Real-life examples that illustrate the difference

First example: clothing store

Sales: 100,000 riyals.
Cost of goods: 60,000 riyals.
Operating expenses: 20,000 riyals.
Accounting profit: 20,000 riyals. But the available liquidity is only 5,000 riyals, because 10,000 riyals are credit sales, and 5,000 riyals are new inventory.

Second example: café

Revenues: 70,000 riyals.
Expenses: 50,000 riyals.
Profit: 20,000 riyals. But the café owner bought a new espresso machine for 18,000 riyals, so he only had 2,000 riyals left as cash.

Sixth: Common mistakes in understanding the relationship between profit and liquidity

Confusing cash flow and net profit.
Relying on sales as the sole indicator of success.
Failure to accurately calculate receivables and obligations.
Ignoring the impact of investing in assets on liquidity.

Seventh: How do you talk to the shop owner in a practical way?

Use simple language without complex accounting jargon.
Show examples from the past month to show the difference.
Propose solutions that are immediately actionable.
Explain that liquidity is the “oxygen” of the business, while profit is the “overall health” of the business.

Conclusion

Profit and liquidity are important elements in the success of any business, but they are not the same thing. Profit gives a picture of the financial performance in the medium and long term, while liquidity is what determines the store’s ability to continue on a daily basis. If the store owner can understand this difference and manage it intelligently, he will be able to achieve healthy and sustainable growth. Avoid financial shocks even in times of recession.