Cashflow and profit are two very different things and if you are a business owner it is crucial for you the understand the differences. Mistaking cash flow for profit, and vice versa, could lead to serious problems; a business can be highly profitable while having a poor cash flow, while a healthy cash flow is not necessarily an indicator how profitable a business truly is. Here is some advice the outlines the major differences between cash flow and profit and the significance of these two financial metrics.
Cash flow is the money that flows into, and out of your business during a set period of time. Cash flow doesn’t include credit from suppliers, money owed to your business from debtors, or money that you have in the bank.
Cash flow is simply 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.
There are three types of cash flow that businesses should track and analyse to determine the liquidity and solvency of their organisation. These three types of cash flow include; cash flow from operating activities, cash flow from investing activities and cash flow from financing activities. All three of these cash flows will be included in a business’s cash flow statement.
By undertaking a cash flow analysis, businesses compare line items in those three cash flow categories to decipher where all the money is coming in, and where it’s going out. From this, they can reach conclusions about the current state of the business.
In comparison to cash flow, profit which can also be 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.
Although raising profits is highly beneficial for your company’s bottom line, it is super important to remember that new sources of profitability such as the development of a new product might increase expenses, pushing costs beyond the breakeven point and causing your company to run out of money if operations are mismanaged.
Cash flow is the money that flows in and out of a business throughout a given period, in comparison profit is whatever remains from your revenue after all of the costs have been deducted. Although profit is capable of showing you the immediate success of your business, cash flow is in many ways a more accurate means of determining your company’s long-term financial outlook. Ultimately, the key difference between the two financial metrics is time.
When you consider the differences between cash flow and profit, it is important to remember that it is very possible for your business to be profitable despite having a poor cash flow. For example, if you run a small business that manufactures electronics selling wholesale products to large companies, delayed payment might mean that you are 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 responsibilities.
Overall, cash flow and net profit measure different things. While profit is the goal and a gauge of how financially healthy a business is cash flow is the lifeblood of a company, keeping operations continuing 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 most important of the two financial measurements.
