Cash Flow vs. Profit: What's the difference and why it matters

Cash Flow vs. Profit

Cash flow and profit are two fundamental financial measures for any business. While it's savvy to focus on both, it's also key to understand each one's unique contribution to business success.

Cash flow measures how money is actually flowing in and out of a business. Managing it closely is essential to ensure that there is enough cash, often referred to as "business oxygen," on hand to pay bills and meet financial commitments. Profit is a different measure altogether. It reveals if a business is making money over a certain period of time once all expenses are subtracted from revenue.

Cash flow and profit are similar in that understanding and tracking both of these measures is essential for business success. Grasping the difference between them is critical to business financial health. A clear example of the difference between them is that a company can be profitable, making money on paper, and at the same time experience cash flow problems. This is because profit reflects performance over time, not what cash is available for use in a business to pay bills and remain solvent.

Learn more about the similarities and differences between these fundamental and critical measures and how to use them in your business.

Understanding cash flow

Cash flow is the actual movement of cash into and out of a business. Maintaining healthy cash flow requires a business to time cash inflows (such as sales and customer payments) and outflows (such as rent and payroll) to maintain enough cash to cover expenses. A mismatch between inflows and outflows can cause cash flow shortfalls.

For example:

• A slow-paying customer of a manufacturing company delays a large invoice, leaving the business without enough cash to cover payroll.
• Bad weather keeps customers away from a retail boutique for weeks, leaving the store short on revenue to cover rent and supplier payments.

Cash flow management helps a business avoid cash flow surprises and take steps to line up funds to cover a shortfall. For instance, a business that anticipates an impending cash shortage can curtail spending, pursue financing or reach out to suppliers to arrange a payment plan.

Why it’s important

Tracking cash flow shows how well a business can meet current and upcoming financial obligations. Here are three reasons it's such a critical metric:

1. Reveals how well a company's cash flow supports business operations. Routine shortfalls may mean a business needs to charge more, bill more quickly, improve collections or use a new payments system.
2. Provides advance notice of cash flow issues. Tracking cash flow reveals impending cash tight spots while there is time to do something about them. This is important because most businesses, even profitable ones, experience cash flow issues at some point.
3. Informs decision-making. Awareness of cash flow shortages or surpluses helps a company make choices about hiring, spending, sales, and just about every important aspect of business management.

Understanding profit

Profit shows if a business is earning more than it spends over a set period such as a month, quarter or year. It is calculated by subtracting wages, rent, supplies, taxes and other expenses from total revenue. Unlike cash flow, which tracks timing, profit reveals if the business makes money once revenue is collected and bills are paid. Even if cash is briefly tight, steady profitability proves the company generates positive returns.

Why profit is important:

1. Informs decision-making. Profitable companies may feel confident investing in new locations, machinery, technology or staff. A lack of profitability may reveal issues that need to be addressed.
2. Supports cash flow management. Profitability does not ensure healthy cash flow, due to payment timing and other factors, but a lack of profit may prompt a business to plan for impending cash shortages by seeking financing, cutting costs or taking other steps.
3. Fuels credibility. Investors, partners and others look closely at business profitability when they are assessing a company.

Key differences between cash flow and profit

Together, cash flow and profit provide a clear view of a company's financial status.

How do cash flow and profit work together?

Tracking cash flow and profit together provides a comprehensive picture of business financial health. Cash flow shows whether a company is managing inflows and outflows to sustain business momentum and avoid the negative impact of a cash flow shortage. Profit reveals whether business operations during a given period are solid enough to result in left over cash once all expenses are paid. Both measures provide insight into what's working and where a business may need to make changes.

For example:

A florist makes strong Valentine's Day sales but runs short on cash when suppliers demand payment before customers settle invoices. This reveals that the business needs to focus on speeding up customer payments or have cash on hand to cover the gap. On the profit side, the florist covers all expenses and ends the month with money left over, showing its pricing and operations are working.

A construction company routinely dips into deposits from future jobs to cover payroll because clients delay payment on current work, indicating that it may need to bill more quickly or line up financing to cover the timing- related shortfall. The same company ends most projects with costs exceeding the contract price, showing the need to raise prices or work more efficiently.

Cash flow vs. profit FAQs

Which is more important: cash flow or profit?

Both matter, but in different ways. Profit shows whether your business is making money after expenses. Cash flow shows whether you have money available to pay for expenses on time. Profit may be a better indicator of long-term financial health, while cash flow indicates whether a business is equipped to cover the costs of day-to-day operations.

Why is cash flow important if my business is profitable?

Profit doesn't reflect the actual timing of money moving in and out of a business. Even with healthy profits, a business may still face cash flow struggles because of late customer payments or an unexpected expense. Positive cash flow is what ensures bills, employees and suppliers are paid on time. It also helps companies protect their business credibility with staff, suppliers and customers.

Can a business make a profit and have negative cash flow?

Yes. You can show a profit on paper but still not have enough cash available when bills are due. This may happen when money is tied up in unpaid invoices or when an unexpected expense drains available cash. Profit indicates cash that will arrive at some point, but cash flow tracks actual inflows and outflows.

Understanding the difference between cash flow and profit helps to make it clear that each measure is vital and uniquely valuable. Cash flow, business oxygen, is essential to keep a business solvent, maintain important relationships, and protect company credibility. Profit reveals whether the way a business is running is good enough to generate profit. Neither one paints a full enough picture to stand alone as evidence that a business will run smoothly. Together, they provide a comprehensive picture of what's working and the changes that are needed. By tracking both measures, and regularly reviewing income statements, balance sheets and cash flow statements, a business owner can gain a clearer picture of their company's financial health and make informed decisions.

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