A lot of businesses mistake profit and cash flow for being the same thing.
It is not.
We repeat – cash flow is NOT the same thing as profit.
Getting this wrong can be the reason your business fails.
Because over 90% of businesses fail because they run out of cash, not profit.
There are many unprofitable businesses that are still standing. we can’t name one business that ran out of cash that is still standing.
In this post, we’re going to break down the difference between profit and cash flow.
By the end of this post, you will not have to think twice about cash flow versus profit.
With that said, let’s talk about cash flow vs profits.
Cash Flow vs Profit: What is Cash Flow?
Cash flow is simply the flow of CASH, aka MONEY, paper, bread, cheddar, and so on – in and out of your business.
Most people look at cash flow in terms of positives and negatives.
A positive cash flow means that your company is adding more cash to your account than it’s losing.
A negative cash flow means that your company is burning more cash from your account than it’s adding.
A positive cash flow is obviously ideal, but many business owners get this confused with profit.
Cash Flow vs Profit: What is Profit?
Profit is the financial gain or loss between the amount of money you EARNED and the amount of expenses INCURRED.
These two words, earned and incurred, are the biggest difference between cash flow and profit.
You see, you can EARN money but never receive it.
For example, you can cut someone’s grass and technically earn their money.
But if they don’t have the money to pay you, then you would not receive any cash despite you earning that money.
Likewise, you can OWE money for expenses but never pay it.
For example, we had a client that loved to pay us late.
Like VERY late – months late at the time.
We hated it. We’d perform a service for him, and he’d write us a postdated check that we could cash for weeks on end.
But he did this to manage his cash flow. He delayed paying his expenses because he did not want to jeopardize his cash flow and ultimately, mismanage his business.
The biggest mistake business owners make when assessing the financial health of their companies is that they put too much emphasis on the income statement, also known as the profit and loss statement.
However, this statement only shows you the revenue you earned minus the expenses you incurred, it tells you NOTHING about the lifeline that keeps your business open – cash flow.
So instead of looking at just the profit and loss statement, which is revenue minus expenses, you should also look at your cash flow statement.
Before we go into the cash flow statement, you need to understand how cash flow is calculated.
How is Cash Flow Calculated?
To calculate your cash flow for a period of time, start with your opening cash balance. This should be the balance that is in your business bank account.
Then add all CASH inflows to that account, minus all CASH outflows to your account.
Forget about all the money you think you EARNED or that you EXPECT to receive. Your current cash flow standing is right there in your bank account.
That’s your current reality, nothing more, nothing less.
What is a Cash Flow Statement?
A cash flow statement is a statement that outlines the cash flow in your business.
Ideally, you would look at this every month.
This report can be broken out into 3 major sections – operating activities, financing activities, and investing activities.
1. Operating activities
These are cash inflows and outflows from the normal operating activities inside of your business, like cash from customers or cash paid to suppliers.
2. Financing activities
These are cash inflows and outflows related to financing your business, such as receiving money from loans or paying interest on your liabilities.
3. Investing activities
These are cash inflows and outflows related to purchasing assets for your business, like buying property or equipment that will be utilized for some period of time.
So that’s what cash flow is and the major components of the cash flow statement.
But what if you don’t have access to a cash flow statement?
If you’re unable to generate a cash flow statement, then we’d recommend that you look at your Profit & Loss statement on a cash-basis.
This is another way to gain SOME understanding of your business cash position.
Typically, there are 2 ways you can look at your profit & loss statement – on an accrual basis or cash basis.
An accrual basis financial statement does not account for your cash flow at all. It simply looks at revenue earned minus expenses incurred.
A cash-basis financial statement does not account for your cash. Cash coming into your business would generally be considered revenue. And cash leaving your business would be considered expenses.
Unless it’s not of course – you can still classify loan payments and bank transfers as balance sheet items since those are liabilities and assets.
Now, how can you bridge the gap between your profit and cash flow, and increase your cash flow?
How to Increase Your Cash Flow?
There is a list of things you can do to improve the cash flow in your business. But here are the major things that we’d recommend.
1. Look at your cash flow.
If you don’t understand this, then nothing else we tell you will help.
2. Find ways to increase your speed of collections.
For example, instead of sending invoices for services or products you sell, ask for an electronic form of payment from your customers so you can charge them right away.
3. Find ways to decrease your speed of payments.
For example, you can negotiate payment terms with your vendors to pay them after services are rendered, or after 15-30 days.
But if you’re anything like us, then you probably hate owing people money and therefore, we’d only delay the speed of paying your vendors as the last resort.
Alright, now that you understand the difference between cash flow vs profit, let’s quickly recap today’s post.
Today we defined the difference between cash flow and profit.
Remember, profit is the financial gain or loss between the amount of money you EARNED and the amount of expenses INCURRED.
Cash flow is simply the flow of CASH in and out of your business.
To understand your cash flow, look at your cash-flow statement every month, or a cash-basis profit and loss statement.
So that’s it for today’s post.
We hope you found this post useful and interesting. If you need help in managing your business financial statements then LYFE Accounting has a team of experts to help you.
Get in touch with us today at 470-240-1437.