What is the Difference Between Profit and Cash Flow?
The primary difference between profit and cash flow is that cash flow is a measurement of money flowing into and out of a business, while profit is the money remaining in the business after all expenses have been paid.
Both profitability and cash flow are important to understand if you want to manage your business effectively. By using both profitability modeling and cash flow analysis, you can get a clear picture of your business’s financial health. This will allow you to make informed decisions about how to grow your business and maximize its profitability.
The Importance of Profitability Modeling
The workplace comic Dilbert puts this in perspective in a strip talking about strategy. The executive says, “We need a clear strategy. Does anyone have a suggestion?” Dilbert turns and responds, “Let’s figure out what makes the most profit. And then do more of it.” The executive quickly responds, “It needs to be less clear than that.”
In a hilarious satire of organizational strategy, Dilbert points to one very specific thing. To grow our business, we need a very clear roadmap on how to get there.
One of the best ways we can do that is by understanding our financial statements and using them to measure the success of our company to plan for the future.
You can also use scenario planning software like the one from Profit Frog to estimate changes in the value of your business and its profitability under different future what-ifs.
What is Profit in Business?
Profit is defined as the difference between the total revenue and total costs of a business. In other words, it’s the amount of money that a business brings in after all expenses have been paid.
Profit is important because it allows you to reinvest in your business, pay yourself a salary, and cover any other costs associated with running your business. without profit, your business would quickly become unsustainable.
So, if you’re looking to build a healthy and successful business, make sure you’re keeping an eye on your profit margin, and get comfortable reading a profit and loss statement.
Types of Profit
In the corporate world, three types of profits are commonly referred to. They are gross profit, operating profit, and net profit.
- Gross profit is the difference between the revenue a business brings in and the cost of goods sold.
- Operating profit is the difference between gross profit and operating expenses.
- Net profit is the difference between operating profit and all other expenses.
Each type of profit can give business owners insight into different areas of their company and help them make informed decisions about their business that lead to profit optimization.
What is the Profit and Loss Statement?
Investopedia defines profit and loss (P&L) as “…a financial statement that summarizes the revenues, costs, and expenses incurred during a specified period, usually a fiscal quarter or year.” The definition also continues to say it is synonymous with an income statement.
In short, the profit and loss statement is the best way to get a snapshot of what your business is earning and spending. It’s based on a static time cycle or period and it is used for reporting and looking into the past.
At its basic level, the equation for a P&L statement is Revenues – Expenses = Profit.
Here’s what a simplified P&L might contain. (This is not accounting advice, only a visual example.)
Joe’s Consulting Inc.
October 1- December 31, 2019
Total Revenue $120,000
Cost of Goods Sold $32,000
Total Operating Expenses ($52,000)
Gross Profit $68,000
Total Overhead ($19,000)
Operating Income $49,000
Earnings before taxes $49,000
Net Income $37,500
Depending on the stage of your business, you may require a more in-depth statement. However, this gives you an idea of what to expect and look for in a P&L.
What is Cash Flow in Business?
Cash flow is the lifeblood of any business. It’s a measure of the cash coming in and out of your business over a period of time.
Positive cash flow means you have more cash coming in than going out.
Negative cash flow is the opposite – more cash is leaving your business than coming in.
Sustained negative cash flow can make it hard to pay your bills and cover other expenses. This is because cash flow affects the amount of money available to fund your business’ day-to-day operations, otherwise known as working capital.
If you’re starting a new business or expanding an existing one, it’s critical to remain on top of the data and keep an eye on the next 12 months.
Cash Flow Definition
Business owners need to know “how much money is in the bank right now?”. A cash flow statement answers that.
Cash flow (CF) is the increase or decrease in the cash an entity has on hand.
Cash flow can be positive or negative, but the term is usually used to describe cash inflows (receipts) and cash outflows (payments).
Cash inflows are important to businesses because they provide the amount of cash that a business needs to use for different business finance operations, pay its bills, expand its operations, and make profits. Without cash inflows, a business would quickly become insolvent.
There are several sources of cash inflows for businesses:
- Accounts receivable are one source of cash inflows. This is money that is owed to the business by its customers.
- The sales of services and products are another source of cash inflows. When a business sells a product or service, it receives cash that it can use to pay its bills and expand its operations.
- Borrowed capital is another source of cash inflows for businesses. When a business borrows money, it receives cash that it can use for various purposes.
- Lines of credit and term loans are two types of borrowed capital that can provide cash inflows for businesses.
Cash outflows are the cash payments a company makes to its creditors.
These cash payments can be for accounts payable, payroll taxes, income tax, inventory, business insurance, rent, credit card payments, equipment financing, business loans, financing activities, or other business expenses.
A company’s cash outflow is important to track because it can give you a good idea of how much cash the company is spending each month. Additionally, cash outflows can help you forecast the company’s future cash needs.
Cash flow is important for businesses because it directly affects the solvency of the business – if cash inflows are greater than cash outflows, then the business is said to be cash flow positive; if cash outflows exceed cash inflows, then the business is said to be cash flow negative.
There are three primary types of cash flow: operating, investing, and financing. Each type of cash flow has different implications for a business.
- Operating cash flows reflect a company’s ability to generate income from its day-to-day operations
- Cash flow from investing reflects a company’s capital expenditures (e.g., buying new equipment or building a new factory)
- Financing cash flows show how much a company is borrowing or paying back in loans and other forms of debt.
A company’s overall cash flow position is the net result of all three types of cash flow – if a company’s total cash inflows exceed its total cash outflows, then the company is said to have a positive net cash flow; if total cash outflows exceed total cash inflows, then the company is said to have a negative net cash flow.
Generally speaking, companies with positive net cash flows are considered to be in good financial health, while those with negative net cash flows may be at risk of financial distress.
Understanding a Cash Flow Statement
To keep track of their cash flow, businesses typically prepare a cash flow statement, which details all of the company’s receipts and payments over a specific period of time.
Investopedia defines it as “… a financial statement that provides aggregate data regarding all cash inflows a company receives from its ongoing operations and external investment sources.”
In other words, it’s a financial statement that measures and tracks the incoming and outgoing of your company’s cash.
Why is this important?
The cash flow statement is one of the key financial statements used by accountants and business managers to assess the financial health of a company. It shows how cash moves in and out of a business, and can be used to identify potential cash flow problems.
- If customers buy your product or service but fail to pay in time, you need to know because it’s not going to be reflected in your bank account.
- When your business pays expenses, rent, and other costly commitments, it might not be able to pay everything all at once. Managing your cash flow helps space out the time to balance the earnings coming in, and when you can pay for bills.
A cash flow is a simple yet very necessary process. 82% of small businesses fail because of poor cash flow management. They can be making a profit, but if there isn’t enough cash in the bank when they need it, they might never see it before closing the doors for good.
What is The Cash Flow Formula
When it comes to cash flow, there are a few key terms to understand.
- Free cash flow is cash available after operating and capital expenses are subtracted.
- Cash flow from operating activities is money that flows in and out of your business from its day-to-day operations.
- A cash flow forecast is an estimate of future cash flows, based on performance from past time periods as well as current trends.
Cash flows can give you control over how the business operates. Understanding cash flow helps your cash be managed well so that you don’t have to worry about it every day.
Here is a basic example of the kind of numbers you will find in a cash flow statement. (This is not accounting advice, only a visual example.)
Lulu’s Tiki Gift Shop Inc.
Cash Flow Statement
Month Ended March 31, 2020
Operating Cash Flows
Cash received from customers $20,000
Cash paid for marketing ($6,000)
Net Operating Cash Flows $14,000
Investing Cash Flows
Purchase of Inventory ($3,000)
Net Investing Cash Flows ($3,000)
Financing Cash Flows
Cash paid for loan repayment ($2,000)
Net Cash Flow from Financing ($2,000)
Net Increase in Cash $9,000
As you can see, cash flow is all about what’s happening now. It follows the money, how much is coming in and how much is going out.
The Difference Between the P&L and Cash Flow Statements
Here are the key differences between cash flow and profit.
A profit and loss statement is great for looking back and measuring the growth of the company, especially when comparing it quarter by quarter or year by year.
A statement of cash flows is great for the operational, real-time side of the business and the movement of cash.
Profit and Loss Statement
- Measures the actual profit of the business vs. its losses
- Functions more as a static report about the past
- Measures reported gains and losses, not necessarily where the cash is
Cash Flow Statement
- Follows the flow of money
- Doesn’t necessarily measure profit and losses, but the amount of money in a company’s account and the amount leaving it at a given time
- Functions more as a real-time snapshot than P&L
Cash Flow vs Profit: a Practical Example
Imagine you are a consultant that negotiated a very specific payment structure. For three months, you want to deliver multiple services to the same client. You set up a fair structure for both you and the client.
25% of the bill is paid at the start of the contract in the first month. For the second month, 50% of the bill is paid since it includes the majority of the work delivered at that time. The third month is realized when the last 25% is paid at the finalization of the project.
Let’s say that your profit and loss statement is quarterly.
100% of the service will show as revenue for that period. You know that you had a good quarter and you made a certain amount of profit. You can now compare it to the last quarter and possibly forecast the next one.
Since the payments are broken up, you have some planning to do.
Your income will be considerably less the first and last month of the project. Your P&L doesn’t reflect it. This is where your monthly cash flow can help plan out how much cash you will have access to throughout the scope of the project. Instead of dealing with a bad month or a difficult cash period, you can plan your business operations around the cash flow.
Both statements can be powerful for your business. Learning how to use them puts you ahead of the game and puts you in control of the business, not the other way around. Once you start using these tools, you’ll feel a sense of freedom knowing the health of your business.
Now that you have a grasp of what a profit and loss and cash flow statement are, you can begin to utilize both to benefit the company.
Profit Frog Can Help
Running a business can be hard.
Sometimes it feels like you are working “in” it and not “on” it. That’s why a platform like Profit Frog makes business simple, allowing you to measure the impact of your business decisions in an easy, practical way. Curious about your profit and loss and how some changes can impact your business? Profit Frog lets you try it out before you take the leap.
Profit and Cash Flow FAQ
Here are some common questions we get about the difference between profit, loss and cash flow. If you have further questions, don’t hesitate to reach out.
Is profit more important than cash flow?
This seems like a simple question, but it’s one that business owners and financial managers grapple with all the time.
On the one hand, profit is a measure of how efficiently a company is generating income. On the other hand, cash flow is a measure of how quickly a company is able to convert its income into cash.
Most businesses focus on profit because it’s a good way to compare apples to apples. After all, two companies could have very different cash flow levels, but if they’re both profitable, that means they’re both doing something right. Profit is also important because it shows whether a company is growing or not. A company that isn’t growing is usually one that’s in trouble.
However, cash flow is just as important as profit. That’s because cash management is what allows a business to pay its bills and keep the lights on. A company could be highly profitable, but if it doesn’t have enough cash to pay its expenses, it will eventually go out of business. That’s why it’s so important for businesses to manage their cash flow carefully.
In the end, profit and cash flow are both important measures of a company’s health. But if you had to choose one, profit would be the more important metric.
Is cash flow the same as profit and loss?
Cash flow and profit and loss are two important financial concepts that are often confused. By understanding the difference between the business cash flow and profit, you can get a better understanding of your company’s overall financial health.
Cash flow refers to the money that is coming in and out of a business, while profit and loss is a measure of whether a business is making or losing money.
Both concepts are important parts of a successful financial planning.
Cash flow is important because it shows how much money a business has available to meet its obligations. Profit and loss, on the other hand, is a measure of whether a business is making money or not.
A business can have positive cash flow but still be losing money if its expenses are greater than its revenue. Conversely, a business can have negative cash flow but still be profitable if it has enough cash on hand to cover its expenses.
While profit and loss give you an overview of a company’s inflow and outflow, cash flow management gives you a more granular look at business’ operating activities including accounts receivable, accounts payable
Why is profit not equal to cash flow?
It’s a common misconception that profit and cash flow are the same thing. However, there are actually some key distinctions between the two.
- Net profit is typically calculated on a per-period basis, while cash flow is a measure of the total cash coming in and going out over a certain period of time.
- Profit takes into account things like depreciation and taxes, while cash flow is simply a measure of the actual cash flowing in and out of the business.
- Profit is what’s left after all expenses are paid, while cash flow includes both income and expenses.
You can easily see why profit is not equal to cash flow from these two examples:
- When a business sells inventory, it recognizes profit, but it does not receive cash until the customer pays for the product. As a result, a business can be profitable but still have negative cash flow.
- Another reason why profit and cash flow can differ is because of expenses. A business may incur expenses that are not due until after the end of the fiscal year, but they must still be paid in cash. This can result in a profit on the income statement but negative cash flow for the period.
All of these factors mean that profit is not equal to cash flow, although they are both important measures of a business’s financial health.