Cash flow and profit are two different financial parameters, but when you’re running a business you need to keep track of both. Here’s how they’re different, why they’re both important and how they intersect with other corporate issues, especially when a company grows rapidly.
A business can be profitable and still not have adequate cash flow. In the worst case, insufficient cashflow in a profitable business can send it into bankruptcy. For example, you’re making products and selling them at a profit. But your product goes through a long sales chain and some of your biggest and most important wholesale customers don’t pay on invoices for 120 days.
Cash flow is the amount and timing of the payments you receive and the expenses that you pay. Specifically, when the money is actually deposited into your bank account or given to you as cash it can be counted as an inflow in your cash flow. When you pay for an expense and the money leaves your bank account or you pay an expense in the form of cash you have on hand, that money is counted as an outflow in your cash flow on that specific day.
Cash flow refers to the inflow and outflow of money from a business. Managing cash flow effectively is necessary for running daily operations, paying taxes, purchasing inventory, and paying employees and other costs. Unlike profit, cash flow is an indicator of how much actual cash is available to a business at any given time.
Your sales may be growing and the money keeps pouring in, but that doesn’t mean you’re making a profit. If you borrow money to solve the cashflow problem, for instance, the rising debt costs that result can raise your costs above the breakeven point. If so, eventually your cash flow will dry up and eventually your business will fail.
A positive cash flow is actually needed to generate profits. You need enough cash to pay your employees and suppliers so that you can make goods. It’s the sale of those goods that helps generate a profit. But if you don’t have the money to make the goods, you don’t end up with the profit. So you really need to structure your business to have a positive cash flow if you want your business to grow and increase profits.
Profit, also called net income, is what remains from sales revenue after all the firm’s expenses are subtracted. It’s obvious in principle that a business cannot long survive unless it is profitable, but sometimes, as with cash flow, the very success of a product can raise expenses.
It may not be immediately apparent that this is a problem. In other cases, you may be aware of the problem, but believe that by reducing production costs you can restore profitability in time to avoid a crisis. Unfortunately, unless you have a clear understanding of all the relevant cost data, you may not act effectively or promptly enough to make the firm profitable again before it runs out of money.
Profit is typically the best indicator of a business’s success as it reflects its ability to actually generate value. No business can truly last long-term without generating a profit.