We understand that for a time-strapped small business owner, it’s very easy to mix up cash flow and profit, especially when your bank account is struggling, but your accountant says you’ve made a net profit. While it’s true they are somewhat related, they each measure very different things about your business’s financial health.
Revenue and profit
Most profit numbers come from your income statement — also called a profit and loss statement, or just a loss statement — which shows your business’s revenue and costs over a set period (a month, quarter or year).
At the top, you’ll 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. You’ll also see the cost of goods sold (COGS) — the exact cost of items or services you sell, like materials, stock purchases, freight, etc. — your ‘goods sold’.
Revenue minus the cost of goods sold gives you your gross profit. Then you subtract operating expenses and other operational costs – things like wages, rent, marketing, utilities and software. What’s 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 you’ve 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. It’s 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 – 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 business’s 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, you’re spending more cash than you’re bringing in right now. That’s not always a bad thing — you might be investing heavily in growth or one-off capital expenditures. However, if you have ongoing cash flow issues, then that’s 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 what’s the real difference between cash flow and profit?
Profit comes from the P&L and breaks down your financial performance over a defined period – 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 — in other words, it shows your ability to stay solvent on a daily basis.
That’s 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 they’re 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 you’ve 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, it’s 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 there’s enough money to meet your financial requirements. When you treat them as partners instead of enemies, you’ll be in a much better position to grow a business that’s financially robust for the long haul.
