2 min read
Cash flow and profit are very different, and if you’re a business owner, it’s vitally important to have a solid grasp of both. Mistaking cash flow for profit, and vice versa, could be a serious misstep; a business can be highly profitable while having a poor cash flow, while a healthy cash flow is not necessarily an indicator of profitability. Here’s our guide to the difference between cash flow and profit and the significance of each of these financial metrics.
What is cash flow?
In a nutshell, cash flow refers to the money that flows into, through, and out of your business during a set period of time. Cash flow doesn’t include credit from suppliers, money owed to you from debtors, or money that you have in the bank – it’s solely concerned with the flow of money into your business over time. In many cases, cash flow is used as a metric for the health of your business, and it’s often utilised by bank lenders and investors to assess how well your company is doing.
What is profit?
In contrast to cash flow, profit (also referred to as “net income”) is the amount of money that remains from your sales revenue after costs have been subtracted. There are two main types of profit:
Gross profit – The profit made by your company after costs that are directly associated with providing goods/services have been deducted.
Net profit – The profit made by your company after all other costs, including taxes and operating expenses (rent, payroll, etc.) have been deducted.
While raising profits is beneficial for your company’s bottom line, it’s important to remember that new sources of profitability – such as the development of a new product – may raise expenses, pushing costs beyond the breakeven point and causing your company to run out of money if operations are mismanaged.
Cash flow vs. profit: What’s the difference?
So, is cash flow the same as profit? No, there are stark differences between the two metrics. Cash flow is the money that flows in and out of your business throughout a given period, while profit is whatever remains from your revenue after costs are deducted. While profit will show you the immediate success of your business, cash flow may be a more astute means of determining your company’s long-term financial outlook. In this sense, the key difference between the two metrics is time.
When you consider cash flow vs profit, it’s also important to remember that it’s completely possible for your business to be profitable while having a poor cash flow. For example, if you’re a small electronics manufacturer selling wholesale products to large companies, delayed payment (which is not uncommon for large corporations) could mean that you’re unable to pay your suppliers. Even if you have a successful product with rising sales, you could end up facing cash flow issues, and despite reaching profitability, your business may be unable to meet its financial obligations.
Is cash flow more important than profit?
Ultimately, cash flow and net profit measure different things. While profit is the goal – and an indicator of financial health – cash flow is the lifeblood of an organisation, keeping operations ticking over on a day-to-day basis. For a growing business, both cash flow and net profit are important, but in the short-term, cash flow is probably the number one concern.
Can growth lead to cash flow problems?
While it seems counterintuitive, it is possible for the growth of your business to generate issues with cash flow. For example, during a period of high growth, a company may accept too many orders without having enough cash to produce them, making it necessary to sell stock or seek a loan. That’s why it’s so important to understand cash flow vs profit and – in some instances – to be willing to take your foot off the accelerator for the sake of your company’s long-term prospects.
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