There are several important financial metrics that every business should be aware of, with two of these being cash flow and profit. Some who are new to accounting and finance sometimes confuse these two terms, but they are not the same or interchangeable. Hence, every business owner must know the differences between cash flow vs. profit to help make better decisions regarding the company's financial health and business performance. Today we'll take a look at these two terms and discuss everything you need to know.
Cash Flow vs. Profit
Profit and cash flow are two very different metrics that can lead to huge missteps if mistaken for one another. So, first, you should know that even a profitable business can have poor cash flow, and alternatively, just because a company has a healthy cash flow doesn't mean it's profitable. Let's take a look at cash flow vs. profit in more depth.
What is Cash Flow?
Cash flow is the physical money earned from operations, investments, and financing that flows through a company. Essentially, it's any cash you have available to cover operational costs such as rent, suppliers, insurance, employees, and such.
A company with insufficient cash flow does not have money available to cover all of its expenses. And it's important to understand that this can happen to companies that are earning a profit on services or products. For example, a growing company may suddenly find that it has a cash flow crisis due to the demand for a newly successful product.
As you can see, cash flow can be negative or positive, where positive cash flow refers to having more money coming in than going out. Alternatively, negative cash flow occurs when there's more money going out than coming in.
What is Profit?
Profit is also known as net income, and it's what remains from a company's revenue after all expenses have been debited. Businesses do not survive if they're not profitable because they spend more money than they earn.
Much the same as with cash flow, a newly successful product can temporarily increase expenses and therefore lower profit. One way of making a company more profitable is to lower costs, but this requires proper planning as any cuts made need not compromise the company's ability to stay open.
Keep in mind that there are two types of profit:
● Gross Profit - This refers to any profit made after costs directly associated with providing services and goods are deducted.
● Net Profit - This is the profit a company earns after every cost, including operating expenses and taxes, is deducted.
Key Takeaways: Cash Flow vs. Profit
The bottom line is that cash flow refers to the physical money moving through a business, whereas profit is the income earned after all expenses are subtracted from revenue. Always remember that some businesses are profitable without good cash flow, and others have good cash flow but don't turn a profit. The fact is many companies struggle with one or the other, and this issue can be exacerbated by unexpected or rapid growth. So, it's always a great idea to hire a professional accountant or bookkeeper to manage both of these metrics properly and help you make the right business decisions.