Profit and Cash Flow: What You Might Not Know

Profit and cash flow. Two standard metrics that every business owner is familiar with, right? 

You’d be surprised. 

While folks typically have a general sense of what profit and cash flow are, they don’t always grasp the details and nuanced differences. 

Let’s dig in.  

Profit 101

Profit is often referred to as net income. It’s the amount left after subtracting all expenses from total revenue. Typically reported on the income statement, profit is a key indicator of a company's financial performance. There are three primary profit types:

1. Gross Profit. Gross profit is revenue minus the cost of goods sold (COGS), which includes direct costs like materials and labor. Gross profit shows how efficiently a company uses its resources. 

2. Operating Profit. Operating profit is gross profit minus operating expenses such as rent, salaries, and utilities. An operating profit shows that a business can generate more money than it spends. 

3. Net Profit. Net profit is the final profit after deducting taxes, interest, and all other expenses. It’s a true indicator of a business’ financial health.

While profit is a strong measure of success, it doesn’t necessarily reflect the liquidity or cash available to the business at any given time.

Cash Flow Basics

Cash flow refers to the movement of money in and out of a business over a specific period. It is documented in the cash flow statement, which categorizes cash activities into three areas:

1. Operating Cash Flow. Operating cash flow is money generated from core business activities, such as sales and expenses.

2. Investing Cash Flow. Investing cash flow is cash used for purchasing assets, investments, or long-term business growth.

3. Financing Cash Flow. Financing cash flow is money from loans, equity financing, or dividends paid to shareholders.

A positive cash flow means a business has more money coming in than going out and can meet short-term obligations like payroll and supplier payments.

Key Differences Between Profit and Cash Flow

This handy breakdown covers the key differences between profit and cash flow: 

Profit…

…Measures earnings after expenses

…Is reported on the income statement

…Includes non-cash items

…Determines profitability

…Affects long-term growth and valuation

Cash Flow

…Measures actual movement of cash

…Is reported on the cash flow statement

…Includes only cash transactions

…Determines business liquidity

…Affects short-term financial stability

Why Cash Flow Matters More Than Profit in Some Cases

Even if a business is profitable on paper, it can still run into trouble if it lacks sufficient cash flow. Here’s why:

• Delayed Payments. High sales and recorded profit don’t mean much if customers delay payments.

• Inventory and Expenses. Buying inventory or covering operational costs requires actual cash, not just profits on paper.

• Debt Obligations. Loan payments require cash, not just a good profit margin.

• Seasonal Fluctuations. Businesses with seasonal revenue might have months where profit is high but cash flow is low.

How to Improve Both Profit and Cash Flow

There are a few simple ways businesses can improve profit and cash flow: 

1. Actually Watch Your Cash Flow! This is the best way to avoid surprises.

2. Optimize Receivables. Make it easy for your customers to pay you. (We set our clients up with Bill to improve cash flow.)

3. Control Expenses. Cut unnecessary costs and negotiate better terms with suppliers.

4. If You Have Inventory, Manage it Thoughtfully. Avoid overstocking, which can tie up cash in unsold goods.

5. Plan for Taxes. Ensure you set aside enough cash for tax obligations to prevent cash shortages. And make those quarterly estimated payments!

Have Questions?

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