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Cash flow vs. profit - what's the difference?

Ollie Maitland Jul 03, 2024

As a small business owner there are two key concepts which can impact your business finances: cash flow and profit. While they might sound similar, they serve different purposes and understanding the distinction between the two can make a significant difference in managing your business effectively. Let’s break it down in simple terms.

What is profit?

When people say “profit” they usually mean the amount of money your business has left over after all expenses have been paid. It’s what remains from your revenue after you’ve deducted costs like salaries, rent, supplies, and taxes. Profit is usually calculated over a specific period, such as a month, quarter, or year, and it comes in three forms:

  • Gross profit: This is your total revenue minus the cost of goods sold. It gives you a basic idea of how much money you’re making from selling your products or services before any other expenses are taken into account.
  • Operating profit: Also known as operating income, this is your gross profit minus operating expenses (rent, utilities, salaries, etc.). It reflects the profit made from your core business operations.
  • Net profit: This is the final profit after all expenses, including taxes and interest, have been deducted from your total revenue. It’s the most comprehensive measure of your business’s profitability.

What is cash flow?

Cash flow, on the other hand, refers to the movement of money in and out of your business. It tracks the actual cash that comes into your business from sales or investments and the cash that goes out for expenses, loan repayments, and other payments. Cash flow is categorised into three types:

  • Operating cash flow: This is the cash generated from your day-to-day business operations. It includes cash received from customers and cash paid for operating expenses.
  • Net cash flow: This is the difference between all cash inflows and outflows over a specific period. It provides a snapshot of your overall cash position during that time frame.
  • Free cash flow: This is the cash remaining after your business has met all its operating expenses and capital expenditures. Free cash flow in the business might be used for expansion, or reducing debt for example. 

Key differences between cash flow and profit

Here’s a breakdown of the key differences between cash flow and profit: 

  • Cash flow tracks the actual movement of money in and out of your business at the moment it happens. Profit, however, is recorded when transactions occur, not necessarily when cash changes hands. For example, you might make a sale or send an invoice today (profit) but not receive payment until next month (cash flow).
  • Cash flow focuses on liquidity - how much cash you have available to use right now. Profit focuses on overall financial performance and sustainability over time.
  • Managing cash flow helps you ensure you have enough money to meet immediate needs. Monitoring profit helps you understand the long-term viability and growth potential of your business.

As the old saying goes, businesses don’t go out of business because they are not profitable, they go out of business because they run out of cash.

Why both matter

You might wonder why cash flow is important if your profit is high. The reality is, a profitable business can still face cash flow problems. 

For instance, late payments or long payment periods from customers can leave you struggling to pay your bills and suppliers. Even if your profit looks good on paper, your cash flow might be strained because the money you’re owed isn’t in your bank account when you need it. Additionally, investing in new equipment or inventory can drain your cash reserves, even if these purchases are expected to increase profits in the future. Businesses with seasonal ups and downs may have times of high profit but need to manage cash carefully during slower periods to avoid running out of money. 

Understanding and managing both profit and cash flow is essential for the health and stability of your business.

Practical tips for managing cash flow and profit

  1. Keep a close eye on both your profit and cash flow statements to catch any issues early. Creating a cash flow forecast can also help you anticipate and address potential shortfalls before they become problems.
  2. Create a realistic budget that includes all expected income and expenses. This helps you plan for the future and avoid unexpected shortfalls.
  3. Make sure to send out your invoices on time so that your customers are able to pay quickly. You could also consider offering discounts for early payments and penalties for late payments. 
  4. Before working with a customer, partner, or supplier, you should run a company credit check. to see if they usually pay on time and if they are a creditworthy business. This helps you set realistic credit limits to help ensure your cash inflows are not reduced by late or non paying customers. You can create a free Capitalise for Business account today to start checking companies for better credit control and cash flow management.
  5. Regularly review your expenses and look for ways to cut costs without compromising quality. This can improve both your profit and cash flow.
  6. Try to maintain a reserve of cash to cover unexpected expenses or downturns. This can provide a financial safety net and help maintain stability.

If you spot a cash flow gap, you might need external help to keep things running smoothly. Access to finance such as a business loan, could provide the boost you need to cover costs. At Capitalise, we work with over 100 business lenders to help find the right option for your business. Just start a search for funding to find out your options. 

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