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Cash flow describes all of a company’s inflows and outflows of money while profit looks at revenue minus expenses.
These two metrics are closely related but can be used for different things, which is why business owners must understand the distinction.
Cash flow and profit are two closely related metrics. In general, business owners want both measures to be positive but don’t be too worried – there are some situations where negative cash flow, or even profit, is alright.
Cash Flow vs. Profit
Cash flow and profit are two different, though related metrics. Either can be a positive or negative number.
Cash flow looks at all of a company’s inflows and outflows of cash, including revenue but also borrowed money.
Profit looks at a company’s revenue and subtracts operating expenses to find the money left over after normal operating activities.
What is Cash Flow?
Cash flow is the net inflow or outflow of money for a business. It considers all sources of income and costs, including borrowed money, investment, and normal operating activities. A positive cash flow means a company sees a net inflow of cash while a negative cash flow indicates a net outflow of cash. For more information on overseeing cash flow see small business cash flow management.
Types of Cash Flow
There are three types of cash flow.
- Operating cash flow – this looks at cash flow from normal operating activities, such as income from sales and outflows from paying for supplies, rent, and wages.
- Investing cash flow – this looks at cash flow from buying or selling investments such as securities, real estate, vehicles, and machinery. Negative investing cash flow may indicate a business that is investing in future growth.
- Financing cash flow – this looks at money received from selling equity or loans and money spent on dividends or repaying debt.
The Cash Flow Statement
The cash flow statement contains a list of all of a company’s cash flows, broken down into the three categories above.
It makes it easy for a business owner to see their business’s net cash flow and to see where those cash flows are coming from. By breaking down cash flows into three categories, a business owner can quickly see if they should be concerned.
For example, a negative net cash flow might not be a bad thing if operating cash flow is positive and investing cash flow is negative because the company is buying new equipment to increase future sales.
Similarly, positive cash flow might not be a good thing if it’s coming from selling assets or borrowing money while operating cash flow is negative. For more details check out how to analyze cash flow statement.
What is Profit?
Profit is the amount of money that remains after a company pays all of its expenses. For example, a company that sold $100 worth of goods, spent $50 on supplies, $25 on wages, $5 on taxes, and $5 on interest would generate a profit of $15.
It does not consider things like investments in new equipment or money received from loans in the way that cash flow does.
Types of Profit
There are three types of profit that business owners often look at:
- Gross profit – this looks at revenue minus the cost of goods sold, ignoring some other costs
- Operating profit – this takes gross profit and subtracts out other costs of doing business like rent, depreciation, and utilities
- Net profit – this looks at the amount of money left over after accounting for all cash flows
The Income Statement
A company’s income statement shows a company’s revenue and expenses, broken down into different categories. Business owners can use this statement to calculate their company’s profit and to see where its revenue is coming from and what expenses it pays. For more information on expenses see expenses of a small business.
The Difference Between Cash Flow and Profit
Cash flow and profit are related but show two very different things.
While profit measures the amount of money a company has left over after paying its expenses, cash flow describes the movement of money without worrying about how much is left at the end.
Cash Flow vs. Profit: The Source of Cash Transactions
The source of cash impacts the way that it affects cash flow and profit.
For example, if a business takes out a loan, the money it receives from the lender is a positive cash flow. However, that loan isn’t counted as profit for the company because it isn’t revenue it is generating.
This means that an unprofitable company can have positive cash flows by borrowing money or raising money in other ways.
Similarly, profitable businesses might have negative cash flows if they choose to invest some of their profit into growing the business by buying real estate or equipment.
Cash Flow vs. Profit: Basis of Accounting
Companies typically use one of two accounting methods: accrual accounting or cash accounting.
Under accrual accounting, a company books revenue and expenses when they happen, regardless of when it actually receives or sends payment. Under cash accounting, the transactions don’t hit the company’s books until they are completed.
The method of accounting impacts profit and cash flow calculations.
For example, under accrual accounting, a company can show a profit based on money it is yet to receive. However, that sale won’t influence cash flows until the company actually receives the cash.
Example of Cash Flow vs. Profit
Consider this example to see how cash flow and profit can be different.
A company sells $100,000 worth of products and spends $75,000 on things like wages, supplies, and utilities. The business also takes out a $200,000 loan and spends $150,000 on buying a new piece of machinery.
The company’s profit is $25,000 – which is the amount left over from revenue once it subtracts out expenses.
However, its cash flow is $75,000 because cash flow also includes money received from the loan and spending on investment.
Cash Flow vs. Profit: Which Is More Important to a Business?
Both cash flow and profit are very important for businesses. However, they are important for different reasons.
Why Cash Flow Is Important
Cash flow is important to a business because it describes how money moves in and out of the company’s bank account. If a business has negative cash flow, it needs to have financial reserves available to pay its bills. Otherwise, it’s at risk of going under.
Positive cash flow indicates a company that is increasing the size of its coffers and that can handle its expenses without issue.
Why Profit Is Important
Profit is important because it shows how much money a company gets to keep from its typical operations. An unprofitable company is likely to have issues in the future, even if it has positive cash flow because, at a fundamental level, it is losing money by operating.
How Rapid Business Growth Can Cause Business Failure
Growth is usually a good thing for businesses, but there are some situations where rapid growth can lead to long-term issues for a company or even failure.
For example, if a business puts too much of its money into growing the business, it can result in negative cash flows and a struggle to pay bills. A growing company might also take on too much work, leading to stress and decreasing productivity.
FAQ About Cash Flow vs. Profit
There are many important things to understand about the difference between cash flow and profit.