Cash flow vs. profit: What’s the difference

Cash flow. Profit.

Although these accounting terms might feel similar to finance newbies or people just setting up a business, it’s important to know that they are quite different. 

Cash flow and profit are both indicators of a company’s financial health and viability, but not in the same way. Understanding what each term means, and the difference between cash flow and profit, is a step towards failproofing your business.

What you need to know about cash flow

An organization’s cash flow is a measure of cash inflow minus cash outflow in a given period. In other words, it is the net balance of cash moving in and out of the business during a specific timeframe.

Every company experiences an ebb and flow of cash. For instance, when a business owner pays for lunch for the office, money flows out of the company. When the business sells an item from its stock, money flows in. 

Cash flow covers outgoing expenses, such as employee wages, vendor payments, company phone service bills, debt repayments, rent, and more. It also covers incoming money, such as sales revenue, funds from loans, accounts receivable payments, tax refunds, and even government grants. 

The cash flow statement is a standard financial report that summarizes and analyzes a company’s cash transactions over a designated period. This report includes a company’s opening and closing cash balances. It also details how and why cash was spent or received. 

Your company’s cash flow can be positive or negative. Positive cash flow means more money is coming into the company than going out. Conversely, negative cash flow describes a situation where there’s more money leaving the business than it’s receiving. 

Having a negative cash flow means that funds are not available for things like employee training, marketing, or upgrading your communications infrastructure. This can have a significant impact on your ability to build and grow your business. There are many cash flow apps that help with managing this important facet of your finance.

Common cash flow structures for small businesses

What profit looks like

A company’s net profit is the balance after all expenses are deducted from all revenues. Essentially, it represents the difference between total income from sales and the costs involved in producing and selling goods or services, including operating expenses, taxes, and other costs.

When a company makes a profit, those funds can be reinvested in the company to support growth and development. Profits can also be returned to owners or shareholders in dividends.

An income statement is the standard format for reporting a business’s financial results, including profit and loss, expenses, and revenue, during a given time frame.

Investors love to interrogate profit and loss statements. While analyzing the document, they’ll ask lots of questions like, “I see VoIP costs there. What is a VoIP phone?” It’s therefore critical that you track your expenses and income so you can explain everything on your profit and loss statement.

Types of profit that SMB owners should know

The difference between cash flow and profit

Is cash flow the same as profit? Well, no. Cash flow measures the net flow of cash into and out of a company in a given period, whereas profit measures the leftover revenue after expenses and taxes are paid.

It’s possible for a business to be profitable, yet lacking in cash flow.

For instance, imagine you allow credit as one of the payment methods for your business. When a customer buys on credit, the sale is listed as part of your revenue, but until they actually pay,  you don’t have access to the money — it has not yet flowed into the company. 

Let’s take it a step further: the credit period you provide customers is one week, and you need to pay your suppliers every 10 days. But two customers default on payment, leaving you with less cash flow to pay those suppliers in the immediate term, even though the business is making an overall long-term profit.

The flipside is also true: just because a business has good cash flow doesn’t necessarily indicate profitability.

Let’s assume you urgently need to pay vendors or buy new machinery. You may have personal funds to make the purchase. But because you understand the reasons not to mix up personal and business finance, you decide to take a loan. 

The loan will give your company a healthy inflow of cash. But if the interest on that loan pushes your operating expenses over the zero line, your business is no longer profitable.

Another important thing to consider is the difference between revenue and cash flow. Cash flow is all the money coming in and out of a business — it goes both ways. Revenue is all the money that a business generates during a set period, however, it is not all profit. Once you take out expenses, taxes, salaries, and all other payments and bills, the revenue you are left with is profit.

Why cash flow matters more in the short term

Businesses need cash in hand to meet their immediate financial obligations, such as salaries, vendor payments, rent, and utilities. Cash flow is critical in the short term because it ensures that businesses have the liquidity to pay expenses that keep the business running. 

Positive cash flow ensures that businesses can cover day-to-day expenses and avoid disruptions to business activities. For instance, if a restaurant does not have enough cash flow to pay for extra wait staff, then they won’t be able to take a big booking for a private party, which results in lost sales and opportunities for profit and growth.

When short-term cash flow is restricted, then the business may not have enough funds to make loan repayments on time. This can result in late fees and damage to credit score. Poor cash flow can also mean that there is no cash available to pay suppliers and vendors. Paying late harms vendor relationships and makes it harder to do business.

Of course, little or no cash flow means that there are no reserves for emergency expenses, putting the business at risk in the event of an unforeseen problem, such as equipment breakdown.

Strong short-term cash flow is essential for keeping a business running efficiently, especially during periods of uncertainty or growth.

Why profit matters in the long term

Making a profit is the ultimate aim of any business. For small business owners, profits are the source of income that may be supporting yourself and even your family.

Unlike cash flow, which is a more immediate concern, profit is a longer-term strategy that should be considered with a wider lens. For example, business might be slow for a couple of months, with little or even no profit. However, if the following month brings excellent sales, then the profit is not affected overall, or may even be better than if there had just been three standard months of sales.

In the long term, profit impacts a business’s sustainability and financial health. (Perhaps a business can withstand a few months of no profit, but profits can’t be low forever.)

Long-term profitability gives stability, so the business can reinvest in activities to help sustain revenues or even grow. For example, a profitable delivery business can afford to buy an extra vehicle, expanding to a wider delivery area and increasing its profit potential. Profit also ensures that a business has spare money in the bank to weather economic downturns or changes in the market, helping it to remain competitive over time.

How profit affects cash flow and vice versa

While profit and cash flow are two different concepts, they are closely related and have an impact on one another in both the short and long term:

• How profit affects cash flow: Profit is when a business generates more revenue than expenses. If the profit can be collected from customers quickly, this will increase cash inflow. On the other hand, if a business has sales on credit or unpaid invoices, this might show a profit on paper but doesn’t reflect actual cash in the bank. In this case, cash flow is poor even though the company is profitable.
• How cash flow affects profit: Good cash flow means that the business has enough money in the bank to cover expenses promptly, avoid late fees from suppliers or loan repayments, and even take advantage of early payment discounts. All of this can improve profitability. On the other hand, lack of cash flow is a strain on the business. ITo pay bills, the business may have to take out a loan, increasing its debt and interest payments and reducing profit margins.

Positive cash flow and profitability are obviously the most desired states for a business owner. However, running a business is not always so simple. As long as cash flow and profits are managed effectively, there is room to be flexible and still achieve financial health and success.

Which is more important: cash flow or profit?

Wouldn’t it be great if there was a single indicator of your business’s financial health? If you could just look at cash flow or profit to know exactly where you stand?

Perhaps, but the reality is that both profit and cash flow are critical in their own right. There’s no easy answer to the question of which matters more. Business owners must become familiar with both, and how they affect one another, to truly understand their business’s financial state.

For instance, it’s possible that  an e-commerce business is making money but lacks enough cash on hand to cover costs. To save immediate expenses, the owner decides to scale back on paid advertising campaigns. While this helps with short-term cash flow, it might impact future sales and reduce long-term profitability. 

On the other hand, young and growing businesses may struggle to realize profit despite increasing both their cash flow and their sales. This is an example of what it means to be cash flow positive vs profitable. A long-term financial plan and business strategy will take into account things like customer lifetime value and other factors that can help ensure future profitability when making any important business decisions.

Cash flow and profit are not the same

Does cash flow mean profit? No, but they are both vital to a business. Cash flow represents the cash-on-hand to make moves in the here and now, while profit is what you’re left with when all is said and done. 

You need to know exactly where you are, with both measures, to make sound financial decisions. Growing a business is about manipulating these levers, whether that means spending a little now to increase profits later, or scaling back when your cash flow is low to protect the business over the long term.