Cash Flow vs. Profit: How Are They Different?

Cash Flow vs. Profit

Last Updated December 28, 2023

When business owners need to assess the financial health of their organizations or firms, two essential variables come into play: cash flow and profit.

It’s important to understand cash flow and profit because, while they each influence the other, they have vastly different meanings, causes, and impacts.

In this article, we’ll break down the differences between cash flow and profit, how to find cash flow and profit, and how they impact your business’s financial well-being.

What Is Cash Flow?

Cash flow represents the movement of money into and out of your business over a specific period of time. It encompasses all of your spending and earnings, including sales revenue, expenses, investments, and loans. Understanding how to manage cash flow is vital as it reflects the liquidity of your business – how much cash you have on-hand to cover immediate expenses or take advantage of opportunities.

Why Is Cash Flow Important?

Healthy cash flow keeps your business operations running smoothly. A positive cash flow means you have more cash coming in than going out, ensuring you can meet short-term obligations like payroll, rent, and other bills.

On the other hand, negative cash flow can lead to financial strain and hinder your ability to invest in growth or weather unexpected challenges. If you don’t have an understanding of your cash flow, your business could unexpectedly end up in a tough situation.

How to Calculate Cash Flow

Calculating cash flow involves examining your business’s cash inflows and outflows. The formula for cash flow is straightforward:

Cash Flow = Cash Inflows – Cash Outflows

Remember, cash inflows include everything from sales revenue to loans to investments. Cash outflows encompass expenses like new equipment purchases, maintenance and upkeep, and payroll.

Example of Cash Flow

Let’s take a look at an example of cash flow. Imagine your small retail business had $100,000 in revenue last month. You also spent $60,000 on inventory, $20,000 on rent and utilities, and $5,000 on loan repayments.

Your cash flow for the month would look like this:

Cash Flow = $100,000 (Sales) – $60,000 (Inventory) – $20,000 (Rent & Utilities) – $5,000 (Loan Repayments) = $15,000

In this case, you generated a positive cash flow of $15,000, indicating that you have extra cash available to cover expenses or invest in your business.

What Is Profit?

Profit represents the difference between your business’s total revenue and total expenses over a given period. It’s often referred to as the “bottom line” because it shows whether your business is making money after covering all costs and expenses. Profit provides insights into your business’s profitability, but it does not necessarily reflect your company’s liquidity.

Unlike cash flow, when calculating profit, you will take into account depreciation and amortization. Cash flow, meanwhile, measures the movement of strictly cash-related items.

Why Is Profit Important?

Profitability is essential for long-term business sustainability. A consistently profitable business can reinvest in growth, attract investors, and reward stakeholders.

However, profitability alone doesn’t guarantee healthy long-term cash flow. For instance, you might have high profits on paper, but if your customers are slow to pay or fail to pay entirely, you could endure cash flow problems in the interim.

How to Calculate Profit

Calculating profit involves a straightforward equation:

Profit = Total Revenue – Total Expenses

Total revenue includes all your earnings from sales, while total expenses covers everything you spend to operate your business, such as rent, salaries, and interest on loans.

Example of Profit

Consider a software company that earned $500,000 in revenue last quarter. The business incurred expenses of $300,000 for salaries, $100,000 for marketing, and $50,000 in loan interest. Their profit for the quarter would look like this:

Profit = $500,000 (Revenue) – $300,000 (Salaries) – $100,000 (Marketing) – $50,000 (Loan Interest) = $50,000

In this example of profit, the company achieved a profit of $50,000, indicating that the business operations were financially successful during the quarter.

It should be noted that calculating profit might not be this straightforward for your business since businesses have quite a few expenses. Other potential expenses to consider include depreciation and amortization, fees for software, maintenance and repairs costs, and taxes.

Difference Between Being Cash Flow Positive vs. Profitable

We’ve learned about cash flow vs. profit, but what about the difference between being cash flow positive vs. profitable?

Being cash flow positive means you have more cash coming in than going out of your business on a short-term basis, which helps cover your immediate expenses.

Profitability, on the other hand, considers all revenues and expenses over a longer period and provides insights into the overall financial health of your business.

More often than not, a profitable business will also be one with positive cash flow. However, it’s imperative to remember that this is by no means guaranteed to be the case. A business can be cash flow positive without being profitable and vice versa.

For instance, a company might have had a highly profitable year but simultaneously struggled with cash flow due to slow-paying customers. Conversely, a business could have strong cash flow but eventual minimal profitability due to heavy ongoing expenses that have yet to be accounted for.

Another prime example of cash flow positivity and profitability not going hand-in-hand is when a business uses loans or investments to fund growth and expansion. The process of expanding your business will surely decrease profitability, but receiving a loan or investments from shareholders could help you maintain positive cash flow.

Cash Flow Statement vs. Profit and Loss Statement

To gain a comprehensive view of your business’s financial performance, you’ll rely on two key financial statements: the cash flow statement and the profit and loss statement (P&L), also known as the income statement.

The cash flow statement is where you can outline all of your cash inflows and outflows over a specific period, providing insights into your liquidity and short-term financial stability. It helps you understand where your cash is coming from and where it’s going.

The P&L statement, on the other hand, summarizes your business’s revenues, costs, and expenses during a specific timeframe. It’s where you can calculate your profit by listing all expenses and subtracting the cost from your total revenue. The P&L statement offers a snapshot of your business’s profitability.

Differences Between Cash Flow and Profit

Now, let’s break down the primary differences between cash flow and profit:

Cash Flow Profit
Cash flow reflects the movement of cash in real time.  Profit considers all revenues and expenses over a specified period, usually a month, quarter, or year. 
Cash flow focuses on immediate liquidity and short-term obligations.  Profit assesses the long-term financial health and success of your business. 
Cash flow only accounts for cash transactions.  Profit includes non-cash items like depreciation and amortization. 

Cash Flow vs. Profit FAQs

Let’s address some common questions about cash flow and profit.

What is the difference between free cash flow vs. profit?

Free cash flow is a subset of cash flow that represents the cash available to a business after covering all operating expenses, taxes, and investments. Profit, on the other hand, reflects the overall financial performance of a business. Profit is a very broad measure of a company’s financial health, while free cash flow can more practically show the money a company has available to distribute to investors or fund business growth.

What is the difference between net cash flow vs. profit?

Net cash flow, similar to free cash flow, focuses on the cash movement in and out of a business. Profit considers all revenues and expenses, including non-cash items. Net cash flow is a more immediate indicator of financial liquidity, while profit is a longer-term signal of a business’s financial standing.

Does cash flow affect profit?

Yes, cash flow can impact profit – especially if your business relies on timely cash collections to cover expenses. Delays in cash inflows or excessive cash outflows can affect your profitability by creating liquidity challenges.

How can I improve my cash flow and profit?

Improving cash flow can be achieved by optimizing revenue channels, streamlining accounts receivable processes, and efficiently managing your working capital. Enhancing profitability is a bigger-picture project, requiring a focus on increasing revenue, reducing costs, and maximizing overall operational efficiency.