Being aware of the difference between cash flow and profit is vital for business owners. While both are crucial financial metrics for your organization, confusing them can be a serious misstep. Knowing the difference can help improve the decisions you make and ultimately your business's financial health. Keeping reading for our guide to what each of these terms means, their relationship to each other, and the difference between cash flow and profit.
What is Cash Flow?
Cash is constantly coming in and out of every business. When you are eg paying rent for your business premises, cash flows out. When your customers pay for goods or services, cash flows in. Cash flow refers to the net balance of money coming in, through, or out of your company. However, this does not include credit or money owed to you. The cash flow balance can be negative or positive - positive cash flow indicates that a company has more money moving into it than out of it, while negative cash flow means more money is moving out of the company than coming in. Cash flow is often used to assess a business's financial health. Investors may also consider a company's cash flow when making investment decisions.
There are three main types of cash flow:
- Operating cash flow: Net cash generated from a company's normal business operations.
- Investing cash flow: Net cash generated from a company's investment activities (eg investments in securities and purchases of physical assets like equipment or property).
- Financing cash flow: Net cash generated to finance the company. This can include eg debt, equity, and dividend payments.
Cash flow is typically recorded in a cash flow statement. This is a financial document providing a detailed analysis of what has happened to a business's cash over a period of time. The document details different areas in which cash is leaving or coming into a company's bank accounts.
What is Profit?
Profit refers to the amount of money remaining once costs have been subtracted from the revenue generated through sales. Profit is usually either shared between the owners and shareholders of the company, often in the form of dividend payments, or reinvested back into the business (eg used to finance research and development (R&D) of new products or services). Profit can also be a positive or negative number - the latter is often referred to as a loss.
There is three main types of profit:
- Gross profit: Revenue minus the cost of goods sold (includes variable costs such as cost of materials and labor).
- Operating profit: Net profit generated through a company's normal business operations.
- Net profit: Profit made after all costs, including taxes and operating expenses, are subtracted.
Information about a business's profit can usually be found on the income statement. This document shows the cumulative impact of revenue, gains, expenses, and losses within a specified period of time.
What’s the relationship between Cash Flow and Profit?
Ultimately, the two metrics measure different things. Profit is what every business wants to achieve, it is the income generated, while cash flow can be described as the lifeblood of a company. It keeps your business running daily. While both metrics are important to a new business owner, keeping an eye on your cash flow statement and aiming for positive cash flow should be the priority. Remember - your business can make a profit but have poor cash flow. Business growth can also generate issues with cash flow. If during a period of growth, a business may accept too many orders without having enough cash to produce them, this could lead to cash flow issues.
What is the Difference between Cash Flow and Profit?
While cash flow refers to the capital coming in and out of your business within a specified amount of time, profit is the capital remaining once your costs have been deducted from income. Profit will show you the momentary, immediate success of your business, while cash flows provide you with a more comprehensive and long-term understanding of your company's viability.
- Profit: Remaining income after deducting all the costs needed to be incurred to generate revenue
- Cash flow: The total amount of money that flows in and out to/from an enterprise during a certain period
- Profit: Gross Profit = Revenue (Sales) – COGS/ Net Profit = Revenue – COGS – Operating Expenses – Interest Expense – Taxes
- Cash flow: Cash Inflows - Cash Outflows
- Profit: Gross Profit, Operating Profit, Net Profit
- Cash flow: Operating Cash Flow, Investing Cash Flow, Financing Cash Flow
Cash Flow vs Profit Example
During Company X's yearly financial meeting, Employee A reports an increase in profit compared to the previous fiscal year. However, Employee B remarks that was a shortage of cash in the company’s bank accounts and, therefore, it was not able to pay income tax on the profit. This could, for example, be caused by the company accepting too many orders, but not having enough resources to cover both production cost and taxes.
This is why a business must keep an eye on both its profit and cash flow at all times.
Cash Flow vs Profit FAQs
- Is cash flow more important than profit?
Cash flow can be described as the lifeblood of a company. It keeps your business running daily. While both metrics are important, managing cash flow should be the priority (particularly for young businesses).
- Is cash flow equal to net profit?
Net income is the profit a company has earned for a period after expenses have been deducted, while cash flow describes the cash going in and out of a business.
- Why is profit not the same as cash coming in?
Cash flow only measures cash coming into the business, whereas profits counts eg payment for products or services sold that have not been collected.