We understand that for a time-strapped small business owner, itโs very easy to mix up cash flow and profit, especially when your bank account is struggling, but your accountant says youโve made a net profit. While itโs true they are somewhat related, they each measure very different things about your businessโs financial health.
Revenue and profit
Most profit numbers come from your income statement โ also called a profit and loss statement, or just a loss statement โ which shows your businessโs revenue and costs over a set period (a month, quarter or year).
At the top, youโll see gross revenue (or net sales/net revenue), which is the total sales revenue and other income generated, like rental income or interest income, before costs. Youโll also see the cost of goods sold (COGS) โ the exact cost of items or services you sell, like materials, stock purchases, freight, etc. โ your โgoods soldโ.
Revenue minus the cost of goods sold gives you your gross profit. Then you subtract operating expenses and other operational costs โ things like wages, rent, marketing, utilities and software. Whatโs left after all these costs are accounted for is:
- Operating profit, and then after interest and tax,
- Net profit (aka net income or the net income figure).
This is where profit analysis happens. You look at your net profit margin and overall financial performance to see if youโve got a profitable business with a sustainable business model.
What cash flow really measures
While profit looks at performance, cash flow looks at money flowing into and out of your business on a day-to-day basis.
Your cash flow statement (another useful financial statement, alongside the balance sheet) is all about cash inflows and cash outflows, as well as the cash balance at the end. Itโs usually split into three cash flow types:
- Operating cash flow: Cash from regular business operations (e.g. customers paying invoices, cash paid to suppliers, wages and other bills). These are your company’s core business activities.
- Investing cash flow: Cash spent on or from capital expenditures, business acquisitions, equipment and other company assets.
- Financing cash flow: Loans drawn and repaid, owner drawings, paying dividends and other long-term debt movements.
The cash flow statement shows how much cash is generated (or used) in each area and your net cash flow โ the net flow of cash for the period. Good cash flow management and cash flow analysis here tell you whether you have enough money to meet all your financial obligations, pay employees, keep the ATO happy, pay suppliers and lenders, and more.
Because cash flow only records cash transactions, it adjusts for changes in accounts receivable (money owed to you) and accounts payable. It also strips out non-cash items like depreciation and zeroes in on cash receipts, cash payments, and cash equivalents.
In short, cash flow shows how much cash truly moved through your businessโs cash accounts, not just how much you earned on paper.
Positive vs negative cash flow
Positive cash flow means your cash inflows are higher than your cash outflows right now. Positive cash flow happens when more money is coming in than going out, so you can easily take care of bills, cover operating expenses, meet any other financial obligations and plan for future business growth with greater confidence.
Negative cash flow means the reverse. In other words, youโre spending more cash than youโre bringing in right now. Thatโs not always a bad thing โ you might be investing heavily in growth or one-off capital expenditures. However, if you have ongoing cash flow issues, then thatโs a big red flag for your business’s overall financial health. It might even hint at big financial challenges in your future.
Main differences between cash flow and profit
So whatโs the real difference between cash flow and profit?
Profit comes from the P&L and breaks down your financial performance over a defined period โ how much leftover capital you get after sales revenue, costs and operating expenses. Cash flow, on the other hand, comes from the cash flow statement and looks at all the money moving in and out of your business โ in other words, it shows your ability to stay solvent on a daily basis.
Thatโs the biggest difference in the cash flow vs profit conversation: one is about performance, while the other is about survival.
From a numbers perspective, profit is reported using accrual accounting methods, which can include actual revenue received and money owed (like accounts receivable). Whereas cash flow uses actual cash received and cash paid.
Both are very useful financial metrics, and together theyโre the two most important metrics lenders and investors look at first when judging a business’s financial health.
How both profit and cash flow show up in your reports
For most small businesses, the following three reports will give you the complete picture:
- Profit and loss statement: Where the income statement records revenue, goods sold and expenses to show net income, gross profit, operating profit, and net profit.
- Cash flow statement: Includes operating activities, investing cash flow and financing cash flow to show your overall cash position and cash flow for the given period.
- Balance sheet: Showing assets, liabilities and equity at a particular point in time, so you can see the net balance and how much leftover capital owners really have.
Looking at all three gives you a more detailed overview of your financial health than any single report can.
Making them both work for you
In the end, profit tells you how much profit your business makes over a period, while cash flow tells you whether youโve got the cash to keep your doors open. A business can be losing money on paper and still survive for a while if it has cash reserves, or show profit and still go under because the cash never arrives.
As a business owner, itโs your job to keep an eye on both profit and cash. Use profit to judge whether your business operations are viable and use cash flow to make sure thereโs enough money to meet your financial requirements. When you treat them as partners instead of enemies, youโll be in a much better position to grow a business thatโs financially robust for the long haul.
