We use a lot of terms in business that sound similar but have critical nuances that make them different.
For instance, do you know the difference between cash flow vs profit?
Cash flow and profit often get interchanged carelessly. However, the truth is that cash flow and profit tell very different stories about your finances.
In this episode, we kickstart our new podcast series, Cash Flow Forecasting and Management Series. We define clearly the difference between profit and cash flow and why it's vital to understand both terms. We also discuss what it means to be profitable versus having a healthy cash flow. We'll delve deep into cash flow concepts using cloud-based forecasting software, entrepreneur and CFO perspectives.
Want to know how to tie cash flow and profit together?
Tune in to this episode to learn more about cash flow vs profit!
Here are three reasons why you should continue reading this blog on cash flow:
Discover the nuances of cash flow vs profit.
Learn why profit is not about cash.
Understand why being profitable is different from having a healthy cash flow.
Resources:
Visit Christina Sjahli's website for more insights on cash flow and profit on the Her CEO Journey™ podcast series!
Download this E-Book on Efficient Cash Flow Management so that you can monitor, manage and improve your business cash flow.
What Is Profit?
We also refer to profit as net income. Profit is the remaining amount left after deducting all costs needed to earn revenue. The keyword here is "earn revenue"—not cash. A profitable business can go out of business from running out of money on hand.
Why Profitability Is Important
It’s vital to understand your profitability because of the story profits tell. For instance, the net income between your profit and loss statement may tell different stories:
First, you have a credible business model. Second, your marketing strategy works, which leads to an increase in revenue. An increase in revenue also increases profit. Third, your pricing is accurate — you won't be profitable without the correct pricing. Lastly, you manage your costs well.
Profit Is Not About Cash
The common frustration of founders is when their profits don't reflect their ability to pay for expenses. When this happens, every payroll becomes a struggle to balance your finances. The common misconception that follows is that something is missing from profit. But this is not the case—profit is not about cash.
Take this scenario, for example. A client agrees to purchase worth $10,000 from you. The next step is for your team to issue an invoice amount of $10,000. Once you issue an invoice, revenue becomes recognized even if cash has not moved yet. Assume your business expenses are zero; your profit at this exact moment is $10,000. Only a month later will the client pay in full, but you have already recognized the revenue 30 days earlier.
There is a timing difference between when the business receives the cash and when it recognizes revenue. This timing difference is what we call accrual accounting, and it's valuable data for profit calculation. Thus, we calculate profit based on accrual accounting—not cash.
What Is Cash Flow?
Cash flow is the real-time movement of money into and out of a business. It tells a different story than profit.
Cash flow tells a different story and also shows several questions you need to ask. Firstly, it shows the cash flow conversion cycle or how fast cash comes in and out of business. Secondly, are you collecting payments from customers in a timely manner? Thirdly, do you take advantage of the suppliers' credits? How much of your business cash is tied up as inventory? Lastly, are you timely in predicting when you need external financing?
Positive Cash Flow vs Profit in Businesses
Being a profitable business does not equate to having a healthy cash flow. You may be making an annual business profit while struggling to pay necessary expenses. In this scenario, the business is not losing money. However, the inflows and outflows of cash don’t align.
It is also possible for a company to have positive cash flow and no profit. Here, money likely comes from external sources like investors or lenders instead of cash from the operation.
Either way, every founder needs to understand when to use cash flow vs profit as a metric to make informed critical business decisions. It's the only way for a business to grow and succeed.
10 Powerful Quotes
“[Regarding profit] Remember, we are not talking about cash. A profitable business can go out of business because it is starved of cash.”
"Every founder needs to care about profitability because the story behind profit and net incomes is telling us something."
“If it [marketing strategy] works, then you can see an increase in revenue, which technically is going to increase your profit.”
“Now, the common frustration felt by many founders is when their profits don't reflect their ability to pay for expenses. Every payroll is a struggle to find cash.”
“Negotiation with suppliers isn't about the best pricing. Instead, you are trying to find out how long you can hold off on paying your suppliers.”
"Fortunately, there is nothing missing from profit. It's simply: profit is not about cash."
“In conclusion, profit is calculated based on accrual accounting, not cash. And cash flow is the real movement of money in and out of the business.”
“Being a profitable business does not automatically mean you have a healthy cash flow.”
“It is also possible for a company to have positive cash flow and no profit.”
"...to succeed in business, every founder needs to use profit and cash flow together to better inform critical business decisions."
Enjoy the Her CEO Journey™ Podcast?
The line between cash flow vs profit tends to blur when you enter a new business venture. Once you’re able to evaluate and understand the difference between cash flow and profit, you are sure to form a wiser business decision. If you enjoyed today's episode of Her CEO Journey Podcast on cash flow and profit, hit subscribe and share it with your friends!
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Have any questions about business finance? You can contact me through LinkedIn or schedule a chat with me at any time. You can also suggest topics you're curious about for future episodes to help your business grow. Thanks for listening!
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To fuelling the life you want to live,
Christina