Have you ever wondered what the difference between profit and cash flow was? In this guide, we’re going to answer a lot of different questions, including:
- Is cash flow the same as profit?
- Does cash flow mean profit?
- What is profit in a business?
- Much more
What is cash flow and why is it important?
Cash flow is the sum of your cash inflows minus outflows. You need cash flow for:
- Operating costs
- Inventory purchases
- Taxes
- Daily operations
- Etc.
If you have positive cash flow, you can invest money into the business to help it grow. Conversely, negative cash flow is an indication that your liquid assets are on the decline, which is never a good sign for the future of your business.
Types of Cash Flow
Multiple types of cash flow exist, including:
Operating cash flow
A form of cash flow that considers the net cash that you earn from typical business activities. For example, if you sell pizza and this is your main revenue driver, this is where you would come up with your operating cash flow.
Investing cash flow
Businesses may also have investments, and in this case, you will have investing cash flow. This is the cash that the business receives from:
- Investments
- Asset sales
However, you will also deduct your investments, such as purchasing new equipment. For growth-based businesses, investment cash flow often falls into negative territory.
Financing cash flow
Financing cash flow is the funds that are used to fund the company and includes capital. The activities in this category will also include equity payments, dividends and debt issuance.
What is profit and why is it important?
What’s the difference between profit and cash flow? Profit is the surplus in revenue that you have after subtracting all expenses from revenue.
When your business has to do its taxes, profit will be what your tax is calculated on.
What types of profit exist?
Profit can fall into three categories:
Types of profit
Gross profit
Gross profit is what the business has left after deducting the cost of:
- Product creation and sale
- Cost of providing a service
When calculating gross profit, the formula is:
- Net sales – cost of goods and service
It's important to note that gross profit does not include any of the business's fixed costs, such as production, salaries or other factors.
Operating profit
Your business’s operating profit is how much earnings you’ve generated from your core business operations. You'll want to avoid adding the following into the equation:
- Interest
- Taxes
Additionally, operating profit cannot include ancillary investments, such as the payments from the ownership of other businesses. You will not include non-operating income, and it’s a good indicator of how well a business can turn profits.
Net profit
Net profit is the sum of the business's earnings after deducting all of your expenses. For example, perhaps your business earns $100,000 and has expenses of $40,000 during the calculation period. This means that the net profit is $60,000 for the period.
However, you do need to know your gross profit because it can be negative.
Multiple deductions can be made to come up with your net profit, such as:
- Operating expenses
- Interest payments
- Tax expenses
- Etc.
How does cash flow and profit interact?
Profit and cash flow are integrated and intersect. For example, a business can turn a profit, yet there is a lot of money in accounts receivable. In this case, there’s an interaction because the profits are in limbo and cannot satisfy your cash flow needs to make payroll. Negative profit may not impact cash flow too much yet, but over time, cash flow will begin to go down and the business may not have the funds to pay its debt.
For example, if a company has -$10,000 profit but has a $50,000 loan to pay its debts, the company has positive cash flow. If lender and investor funds fall to $0, there would not be enough profits to cover cash flow needs.
Tech companies are notorious for this because they often have a lot of cash flow and don’t turn a profit.
How?
Investors are funneling money into the company because they believe in the company’s:
- Technology
- Potential
- Management
However, the company survives on loans, lines of credit, selling assets or stock in the company to keep operations going in hopes that it will eventually reach profitability.
There’s a major difference in a profit vs cash flow statement because you’re considering two different calculations.
What’s the Difference Between Cash Flow and Profit
The difference between profit and cash flow is that profit is simply the business’s revenue minus its expenses. Cash flow is the cash inflows and outflows during a reporting period. You may have a lot of cash stuck in accounts receivable that you’ve “earned,” but it doesn’t count towards cash flow until it has been paid for through invoice or direct payment.
Which one is more important for your business?
Cash flow and profit are both integral to your business. However, if you have negative profits or cash flow, it can stifle your business’s growth. It's important for you to monitor both cash flow and profits because, without profit, you will not have positive cash flow from operations.
In terms of importance, you need:
- Cash flow to pay employees and debt
- Profits to keep cash flow positive
You can take out a loan or a line of credit to improve cash flow, but then you’ll have higher debt to satisfy.
How to effectively manage your cash flow with Cash Flow Frog software?
Learning the difference between accounting profit and cash flow is just the first step in ensuring that your business is financially sound. Now, you need to find a way to manage the different types of cash flow in your business.
Cash Flow Frog integrates with the world’s leading accounting platforms and even Excel to allow you to quickly and easily manage your cash flow.
In fact, you can use our platform for:
- Cash flow statements
- Cash flow forecasts and projections
- Customer analysis
- More
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