Cash flow and profit are often used interchangeably, but they don’t mean the same thing. Each term describes important elements of your startup that deserve your time and attention.
Not sure about the differences between cash flow vs. profit? Don’t worry—you’re not alone. Below, we’ll cover all the nitty-gritty details and nuances you need to know to better understand (and use) these important business metrics.
What is cash flow?
Cash flow refers to the money moving in and out of your business during a defined period of time. Positive cash flow means more money flowed in than out, and negative cash flow means more money flowed out than in.
Let’s look at a basic cash flow example:
You bought a candy bar today for $1, but you couldn’t manage to sell it before the end of the day. One dollar flowed out of your business today, but nothing flowed in—that means you had a negative cash flow for the day.
Now, let’s say you sell the candy bar a few days later for $2. One dollar flowed out of your business during the week, but $2 flowed in when you sold the bar—that means you had a positive cash flow for the week.
An important distinction for cash flow is that it refers to money flowing in and out of your business, and that’s different from revenue and expenses. You might make a sale today but not receive the actual payment for another 30 days—that money isn’t flowing into your business until it lands in your hand or your bank account. The same goes for expenses: you might purchase a product or service but not have to pay for it immediately—the money only flows out of your business when the money actually leaves your account or wallet.
Let’s look at an example of this action:
You spent $100 during January on marketing and advertising your new product. You finally land a customer at the end of the month, and they agree to purchase $1,000 worth of inventory. You send them the products with an invoice for a 30-payment deadline, but they don’t pay the invoice until February—that means you experienced negative cash flow in January because you had money flowing out of the business but not into it.
Cash flow statement
You report your cash flow in the cash flow statement. This financial document explains your startup’s exchange of cash during a specific period of time. The period of time element is important here. You don’t measure cash flow at any given time—it’s a measure of the movement of cash over a month, quarter, or year.
This is different from other financial documents, such as a balance sheet. A balance sheet measures your company’s assets, liabilities, and equity as of a specific date—it’s not measuring the movement of cash over time (unless you’re comparing multiple balance sheets to each other). It provides a snapshot.
What is profit?
Profit (also known as net income) refers to the amount of money remaining from your sales revenue after you’ve subtracted all your costs. A profit means you have revenue remaining after subtracting your costs, while a loss means your costs exceeded your revenue.
Profit is typically reported as the following:
- Gross Profit: Profits kept after costs _directly associated _with providing the good and service are deducted. For example, you might subtract inventory, sales commission, and delivery fees from your revenue to find your gross profit.
- Net Profit: Profits kept after all other costs are deducted. This would include subtracting rent, payroll, taxes, and the like.
Profitable startups have leftover capital to use for various purposes:
- Building the business: Reinvest your funds into growing your startup—that might be hiring additional talent, upgrading your products, or expanding your marketing campaigns.
- Distributing dividends: Pass along profits to owners and shareholders in the form of dividends.
- Expanding revenue sources: Look for new ways to make money, especially in light of an economic recession. Consider new product lines or services you can offer so that you don’t have all your eggs in one basket.
- Investing in infrastructure: Consider upgrading your hardware, software, or workspaces. Anticipate your demands for the future, and see if you can get ahead of the curve with infrastructure updates now.
- Paying off long-term debt: Cut down on your monthly bills by paying off long-term debt. This will save you interest in the long run and give you room for other financing opportunities down the road.
While every business’s end goal is profitability, it’s not always quick or easy to achieve. The battle for profitability can often slow growth and lead to missed opportunities. It takes money to make money, and sometimes that means you’ll need to experience months or years of losses to set the stage for long-term profitability.
Income statement
Businesses report their profits in their income statement—also known as a profit and loss statement (P&L). This financial document explains your startup’s revenue and expenses, thus explaining the gains or losses. Like with a cash flow statement, it’s measured over a period of time and not taken as a snapshot.
Cash flow vs. profit: what’s the difference?
While you’ve probably noticed a few differences from looking at the definitions above, here’s a quick overview of cash flow vs. profits:
- Indication: Cash flow shows how much money moves in and out of your business, while profit illustrates how much money is left over after you’ve paid all your expenses.
- Statement: Cash flow is reported on the cash flow statement, and profits can be found in the income statement.
- Simultaneous: It’s possible for a business to be profitable and have a negative cash flow at the same time. It’s also possible for a business to have positive cash flow and no profits.
Is cash flow or profit more important?
Neither cash flow nor profit is more important than the other—both illustrate different facts and information about your startup. There’s rarely a single golden metric for understanding the health of a startup. Usually, it requires context and a handful of financial statements to truly understand the business’s situation and potential.
For example, heading toward an economic recession, investors might be more interested in your cash flow rather than your current profitability. While you might be making profits now, they likely want to see your potential to make profits later when unforeseen circ*mstances hit your business.
Keep an eye on both metrics (and, really, dozens of others) to keep a good pulse on your startup’s financial health. Being proactive about reviewing (and optimizing) these metrics will ensure you’re never surprised by investor or analyst conversations—you’ll always be ready to tackle questions and defend your business.
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