Small Business Guide: Is Cash Flow Different From Profit?
Both cash flow and profit are essential to all businesses, regardless of size. Even though most people use them synonymously, they are entirely different entities. Business owners need to understand the difference between both metrics to optimize their business’s financial health and performance.
Before investors invest money into a startup, they study the company’s cash flow and profit to determine if it is a sound long-term investment or a place they can make passive income in the short term. These metrics also guide business owners when they make critical business decisions.
What Is Cash Flow?
Cash flow is the movement of cash in and out of a business at any time. For a business to operate optimally, it needs to spend money. These expenses usually include running costs, taxes, inventory purchases, employee wages, rent, office lease payments, loan repayments, and so on. Businesses are built to make money, so cash is expected to come in if the company runs as expected.
When a business receives more money than it spends, that is positive cash flow. If it spends more than it receives, that is negative cash flow. Cash flow management is needed for small businesses to survive. If not, they will spend their way into bankruptcy. There are three types of cash flow;
1. Operating Cash Flow
This is the net cash inflow from everyday business activities. This metric should stay positive to keep a small business growing.
2. Investing Cash Flow
This is the net cash flow generated from a business’s investment activities. This usually includes property investments, vehicle purchases, asset sales, and stock market investments. Cash outflow should be positive for a small business that actively invests revenue back into the business.
3. Financing Cash Flow
This is the cash flow between a business, its creditors, investors, and owners. It is used to offset debts, pay royalties, and dividends.
What Is Profit?
Profit is the cash that remains after a business has deducted its expenses from its total revenue. The profits of a small business are usually given to the business owner and shareholders or put back into the company. A business’s tax is calculated based on its profits, not revenue.
Similar to cash flow, profits can either be positive or negative. If negative, the company is losing money by spending more overall than they make. If positive, then it is making more than it spends. There are three types of profits:
1. Gross Profit
This is the profit a business realizes after deducting the cost of producing the goods sold to generate its revenue.
2. Operating Profit
This is the profit a business gets from its regular operations. Money spent on tax, loan repayments, rent, and income from areas outside the core business is not accounted for here.
3. Net Profit
This is all the profit realized after all the expenses have been subtracted from all the income.
Cash flow is different from profit because cash flow does not give a clear picture of the overall financial health of a business. However, it is necessary to provide cash that would be spent on day-to-day operations, wages, and so on. On the other hand, profit is the primary goal of a business. It is not always represented by cash.
An increase in asset and property value also counts as profit. It is hard to say which of the two is more important because every business has different circumstances. Regardless, small businesses must maintain healthy cash flow to keep them running and ensure they make a profit to stay operational long-term.
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