Cash flow vs profit: what’s the difference?

If you are like 61% of small business ownersyou regularly encounter cash flow difficulties.

Even if your business is profitable, you can still run the risk of falling into financial bankruptcy. How? If you don’t have enough liquidity (cash flow) to meet the myriad of expenses that come with owning a small business, it can be nearly impossible to maintain your long-term financial position, let alone your business, afloat. .

Many business owners don’t really understand what cash flow versus profit is, so that’s what we’re going to cover in this article.

Cash flow versus profit

Cash flow refers to the money flowing in and out of your business. It’s income and expenses. What you bring and spend. Profit, however, is the money you have after deducting your business expenses from overall income. Both are important, but cash flow is essential to keep your business running in the here and now.

Now, let’s dive deeper into each of these elements to better understand the role cash flow and profit play in your business.

What is cash flow?

Cash flow is essentially the cycle of funds flowing in and out of your business bank account from operating, investing, and financing activities. It is the amount of money you have available to you at any given time. Your business can have positive or negative cash flow.

Positive cash occurs when the ratio of cash inflows is greater than your cash outflows or when there is more money coming into your account than you are spending.

Negative cash flow occurs when your cash outflows are greater than your cash inflows. You spend more than you bring in.

Here are some examples of cash inflows:

You would see them on your income statement.

Cash outflows are any debts, liabilities, or operating costs that running your business may incur. The following are examples of cash outflows (also called cash outflows):

  • Money goes out for accounts payable
  • Social charges
  • Inventory
  • Lease
  • Loan repayments
  • Other business expenses

If you decided to borrow $75,000 in equipment financing, the lump sum of capital you would receive upfront would be considered part of your cash inflows, and your payments on the loan would be considered part of your cash outflows. .

What is profit?

Profit (also called “net profit” or “net income”) is the amount of money left over after all expenses. – including cost of goods sold (COGS), as well as operating costs, interest payments, loan repayments and taxes – are deducted from your income.

To determine your total profitability, you need to understand both gross profit and net profit.

Gross margin is the difference between your revenue and the total cost of goods sold. For example, suppose you own a flower shop. You bring in $25,000 in revenue in April, but the cost of goods sold (i.e. wholesale flowers) is $10,000. Your gross profit would be $15,000.

Revenue – Cost of Goods Sold (COGS) = Gross Profit

$25,000 – $10,000 = $15,000

Another number here that may be useful is your gross profit margin. If you take your gross profit ($15,000) and divide it by your revenue ($25,000), you arrive at 0.6 or 60% profit margin. It’s pretty awesome! This tells you how well your business is doing financially.

Your gross profit is what you make from selling your flower inventory, but it doesn’t take into account all the other operating expenses of running your flower shop. For example, the cost of rent, electricity, payroll, and advertising are all expenses you must pay with your gross profit. Factoring in your operating expenses, which we’ll say is $5,000, your net profit for April would be $10,000.

Gross Profit – Operating Expenses = Net Profit (or Net Income)

$15,000 – $5,000 = $10,000

With regard to the financial statements, you identify your gross and net profit on the Income statement.

While profitability gives you an overview of your financial situation for a specific period of time in your books, it doesn’t take into account the day-to-day stability of your operation. This is where net cash flow comes in.

What is the difference between cash flow and profit?

While having positive and profitable cash flow may seem much the same at first glance, there is a key difference that is important to understand.

To operate, you need operating cash flow to meet payroll, make rent and insurance payments, and manage the long list of other day-to-day expenses to keep business running as it should. usually.

Many companies use the accrual method, which records income and expenses as you earn or incur them, whether or not the money has been exchanged.

If you send invoices to customers who may not pay those invoices for 30, 60, 90 or even 120 days, your real-time cash position will be very different from your profitability – and you may find yourself without sufficient cash. . to run your business.

Let’s take a single invoice to illustrate this point. You land a huge opportunity with a wedding planner, who needs $15,000 in arrangements for an upcoming wedding. You invoice the customer on May 1 with a 60-day lead time. You must also pay your supplier $8,000 for inventory (flowers) within the next 30 days.

Without taking into account your operating expenses for this transaction, your profit for May would be $7,000 – not bad at all!

But that doesn’t give you a clear picture of your cash flow, because you might not get paid that $15,000 until your $8,000 flower bill is due. This is where cash accounting comes in. Although less commonly used, it is important for assessing how much money you actually have, as income and expenses are only really recorded when money is exchanged. With net-60 terms, you won’t get the money until July 1st. See below :

1st May June 1 July, 1st
Influx $0 $0 $15,000
Exit $0 $8,000 $0
Net cash $0 -$8,000 $7,000

Which is more important to a business: cash flow or profit?

The truth is, cash flow and profits matter. This is not an apples to apples comparison. Although profitability is more important over time, cash flow and the availability of working capital will affect your day-to-day operations and your short-term finances.

There are profitable companies that go bankrupt every year because they have low liquidity. If you don’t have cash to cover your expenses, being profitable overall won’t do you much good.

Cash flow forecast

Cash forecast can help you better understand the ebb and flow of money in and out of your bank account and can help you make sound financial decisions to ensure you don’t suffer from a lack of cash.

You might learn, for example, that even though you offer net-60 terms to your customers, most of your suppliers only offer net-30, which means you won’t always have the funds to pay your bills. You have a few options here: you can revert to net 30 terms for your customers in an effort to align positive and negative cash flows, or you can explore business financing options it would put money in your account so that you can cover your expenses on time.

You could, for example, take out a line of credit that gives you access to cash when you need to pay expenses but don’t have the money to cover them. Then, when your customers pay you, you can repay what you borrowed.

Nav’s Final Word: Cash Flow vs. Profit

Although we looked at a simplified example with a single invoice, if you send multiple invoices with different payment terms while managing day-to-day operational expenses, you can see how difficult it can be to stay out of the red.

That’s why it’s so crucial for small business owners to not only understand the difference between cash flow and profit, but also to find better ways to increase cash. Cash flow management can help your business better predict when you’ll have money in the bank and develop strategies to ensure you never have to make financial decisions out of desperation. A profitable business is one that not only makes an overall profit, but also successfully manages day-to-day cash flow.

If you’re looking for ways to increase your cash flow through business financing or business credit cards, Nav can show you the options you’re likely to qualify for based on your business credit scores and details. other data. Register for a free account today to start seeing your options.

Frequently Asked Questions About Cash Flow and Profit & Loss Statements

This article was originally written on July 10, 2019 and updated on August 18, 2022.

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