Cash flow and profit are not the same things, and it’s critical to understand the difference between them to make key decisions regarding a business’s performance and financial health.
So, here’s everything you need to know about cash flow, profit, and the difference between the two concepts.
CASH FLOW
Cash flow: refers to the net balance of cash moving into and out of a business at a specific point in time.
Cash flow can be positive or negative. Positive cash flow indicates that a company has more money moving into it than out of it. Negative cash flow indicates that a company has more money moving out of it than into it.
Cash flow can be further broken into three major categories:
- Operating cash flow: This refers to the net cash generated from a company’s normal business operations. In actively growing and expanding companies, positive cash flow is required to maintain business growth.
- Investing cash flow: This refers to the net cash generated from a company’s investment-related activities, such as investments in securities, the purchase of physical assets like equipment or property, or the sale of assets. In healthy companies that are actively investing in their businesses, this number will often be in the negative.
- Financing cash flow: This refers specifically to how cash moves between a company and its investors, owners, or creditors. It’s the net cash generated to finance the company and may include debt, equity, and dividend payments.
The Cash Flow Statement
Cash flow is typically reported in the cash flow statement, a financial document designed to provide a detailed analysis of what happened to a business’s cash during a specified period of time. The document shows the different areas in which a company used or received cash and reconciles the beginning and ending cash balances.
PROFIT
Profit: is typically defined as the balance that remains when all of a business’s operating expenses are subtracted from its revenues. It’s what’s left when the books are balanced and expenses are subtracted from proceeds.
Like cash flow, profit can be depicted as a positive or negative number. When this calculation results in a negative number, it’s typically referred to as a loss, because the company spent more money operating than it was able to recoup from those operations.
Like cash flow, profit can be further broken down into three categories:
- Gross profit: Gross profit is defined as revenue minus the cost of goods sold. It includes variable costs, which are dependent upon the level of output, such as cost of materials and labour directly associated with producing the product. It doesn’t include other fixed costs, which a company must pay regardless of output, such as rent and the salary of individuals not involved in producing a product.
- Operating profit: Like operating cash flow, operating profit refers only to the net profit that a company generates from its normal business operations. It typically excludes negative cash flows like tax payments or interest payments on debt. Similarly, it excludes positive cash flows from areas outside of the core business. It’s sometimes referred to as earnings before interest and tax (EBIT).
- Net profit: This is the net income after all expenses have been deducted from all revenues. Typically, this includes expenses like tax and interest payments.
THE INCOME STATEMENT
Information about a company’s profits is typically communicated in its income statement, also known as a profit and loss statement (P&L). This statement summarises the cumulative impact of revenue, gains, expenses, and losses over the course of a specified period of time.
THE DIFFERENCE BETWEEN CASH FLOW AND PROFIT
The key difference between cash flow and profit is that while profit indicates the amount of money left over after all expenses have been paid, cash flow indicates the net flow of cash into and out of a business.
IS CASH FLOW MORE IMPORTANT THAN PROFIT?
Ultimately, cash flow and net profit measure different things. While profit is the goal – and an indicator of financial health – cash flow is the lifeblood of an organisation, keeping operations ticking over on a day-to-day basis. For a growing business, both cash flow and net profit are important, but in the short-term, cash flow is probably the number one concern.