Cash Flow vs Profit: What’s the Difference?
If you are like 61% of small business owners, you regularly struggle with your cash flow.
Even if your business is profitable, you can still run the risk of going bankrupt. How? ‘Or’ What? If you don’t have enough liquidity (cash flow) to deal with the myriad of expenses associated with owning a small business, it can be nearly impossible to maintain your financial position in the long run, let alone your business. business, afloat. .
Many business owners don’t really understand what cash flow is as opposed to profit, so that’s what we’ll cover in this article.
Cash flow to earnings
Cash flow refers to the money that comes in and goes out of your business. These are income and expenses. What you bring in and spend. Profit, however, is the money you have after deducting your business expenses from overall income. Both are important, but cash flow is essential to keep your business running here and now.
Now let’s take a closer look at each of these elements so that you have a better understanding of the role that cash flow and earnings have in your business.
What is cash flow?
Cash flow is basically the cycle of funds entering and leaving your corporate bank account from operating, investing and financing activities. This is the amount of cash you have available at any given time. Your business can either be in positive cash flow or in negative cash flow.
Positive cash flow happens when more money is coming in than what is being paid out, or when there is more money coming into your account than you are spending.
Negative cash flow occurs when your cash outflows are greater than your cash inflows. You spend more than you bring.
Examples of cash inflows are:
- Money from accounts receivable
- Sales of services and products
- Capital borrowed as Credit lines Where term loans
You would see them on your income statement.
Examples of cash outflows (also called cash outflows) are:
- Money out for accounts payable
- Social charges
- To rent
- Loan payments
- Other business expenses
If you decide to borrow $ 75,000 in equipment financing, the lump sum of principal you would receive up front would be considered part of your cash inflow, and your loan payments would be considered part of your cash outflow.
What is the benefit?
Profit (also known as “net profit” or “net income”) is the amount of money that is left after all expenses, including the cost of goods sold (COGS), as well as operating expenses, interest payments, loan payments and taxes – are deducted from your income.
To determine your total profitability, you need to understand both gross profit and net profit.
Gross profit is the difference between your income and the total cost of goods sold. For example, let’s say you own a flower shop. You bring in $ 25,000 in income in April, but the cost of goods sold (i.e. wholesale flowers) is $ 10,000. Your gross profit would be $ 15,000.
Revenue – Cost of Goods Sold (COGS) = Gross profit
$ 25,000 – $ 10,000 = $ 15,000
Another number here that may be helpful is your gross profit margin. If you take your gross profit ($ 15,000) and divide it by your income ($ 25,000), you get a profit margin of 0.6 or 60%. It’s pretty awesome! This tells you how well your business is doing financially.
Moving on … your gross profit is what you make by selling your flower inventory, but it doesn’t factor in all of the other operating expenses involved in running your flower shop. For example, the cost of rent, electricity, payroll, and advertising are all expenses that you have to pay with your gross profit. Taking into account your operating expenses, which we’ll say $ 5,000, your net profit for April would be $ 10,000.
Gross profit – Operating expenses = Net profit (or net income)
$ 15,000 – $ 5,000 = $ 10,000
Regarding the financial statements, you identify your gross and net profit on the Income statement.
While profitability gives you insight into your financial position over a specific accounting period, it does not take into account the day-to-day stability of your operation. This is where net cash flow comes in.
What is the difference between cash flow and profit?
While a positive, profitable cash flow may seem pretty much the same at first glance, there is one significant difference that is important to understand.
To operate, you need operating cash flow to keep up with payroll, make rent and insurance payments, and manage the list of other daily expenses to keep your business running as usual. .
Many companies use the accrual accounting method, which records income and expenses as you earn or incur them, whether or not the money has actually been exchanged.
If you send invoices to customers who may not pay those invoices for 30, 60, 90, or even 120 days, your real-time cash flow situation will be very different from your bottom line – and you could end up without sufficient cash. to run your business.
Let’s use a single invoice to illustrate this point. You land a huge opportunity with a wedding planner, who needs $ 15,000 in arrangements for an upcoming wedding. You invoice the customer on May 1 within 60 days. You must also pay your supplier $ 8,000 for inventory (flowers) within the next 30 days.
Without factoring in your operating expenses for this transaction, your profit for May would be $ 7,000 – not bad at all!
But that doesn’t give you a clear picture of your cash flow, because you might not receive that $ 15,000 until your $ 8,000 flower bill is due. This is where cash accounting comes in. Although it is less commonly used, it is important for gauging how much money you actually have on hand, as income and expenses are only actually recorded after the money is exchanged. With net-60 terms, you won’t receive the money until July 1. See below :
|May 1||June 1||1st of July|
|Influx||$ 0||$ 0||$ 15,000|
|Exit||$ 0||$ 8,000||$ 0|
|Net cash||$ 0||– $ 8,000||$ 7,000|
Which is more important to a business: cash flow or profit?
The truth is, both cash flow and profits matter. This is not an apples to apples comparison. While profitability is more important over time, cash flow and the availability of working capital will affect your day-to-day operations.
There are profitable businesses that go bankrupt every year because they have low cash flow. If you don’t have the cash on hand to cover your expenses, being profitable overall won’t do you much good.
Cash flow forecast
Cash flow forecast can help you better understand the ebb and flow of money in and out of your bank account, and can help you make sound financial decisions to make sure you don’t suffer from a lack of cash.
You might learn, for example, that even if you offer net-60 terms to customers, most of your suppliers only offer net-30 terms, which means you won’t always have the funds to pay your bills. invoices. You have a few options here: you can revert to net-30 terms for your clients with the goal of aligning positive and negative cash flow, or you can explore business financing options this would put money in your account so that you can cover your expenses on time.
For example, you could take out a line of credit that gives you access to cash when you have to pay for expenses but don’t have the money to cover them. Then when your customers pay you, you can pay back what you borrowed.
Nav’s final word: cash flow vs. profit
While we’ve walked through a simplified example with a single invoice, if you send multiple invoices with different payment terms while managing daily operational expenses, you can see how difficult it can be to stay out of the red.
This is why it is so crucial for small business owners not only to understand the difference between cash flow and profit, but also to find better ways to increase cash flow. Managing cash flow can help your business better predict when you’ll have cash in the bank and strategize to ensure you never have to make financial decisions out of desperation. A profitable business is one that not only makes an overall profit, but also successfully manages its daily cash flow.
Rate this article
class = “blarg”>