For small business owners, cash flow and profit are both essential financial metrics to understand. However, it isn’t uncommon for those new to the world of entrepreneurship to confuse the two accounting terms.
Cash flow and profit are not interchangeable and do not mean the same thing. Therefore, it’s important to recognize the difference between the two metrics to make critical decisions when it comes to a business’s profitability and financial health.
Additionally, cash flow and profit are important to investors to determine the potential success of a start-up or established organization. These metrics showcase whether a business is a good investment based on its ability to remain robust, especially in a time of uncertainty.
To provide more context, I’ll share both the definition of cash flow and profit, as well as the difference between the two financial concepts.
What is Cash Flow?
Regardless of what products or services your business provides, one thing is for certain: money is constantly moving in and out.
For example, when a manufacturer purchases inventory, cash flows out of the business to compensate its suppliers. And when the same manufacturer sells an item from their inventory, money moves into the company as paid for by its customers.
This same scenario can be rephrased in many different aspects of an organization. As a result, a metric needed to be created to define this exchange of moving money. Enter the term “cash flow.”
Whether positive or negative, cash flow is the net balance of money moving into and out of a business at a given point in time. Positive cash flow means that an organization is earning more money than it is spending. In contrast, negative cash flow indicates that a company is spending more money than it is making.
Additionally, cash flow can be broken down into different categories, including operating, investing, and financing cash flow.
- Operating cash flow is the sum of money generated from a business’s everyday operations — for example, salaries paid to employees.
- Investing cash flow is the amount of money earned from investment-related activities such as stocks or bonds.
- Financing cash flow defines how money is moved between a business and its owners or investors. For example, financing cash flow can include any debt, equity, and dividend payments.
What is Profit?
Profit refers to the amount of money a company has once its operating costs are subtracted from its proceeds. In other words, it’s the money that is left over after the books are balanced and all expenses are paid.
Depending on the structure of an organization, profit can be given to owners and investors in the form of dividend payments. However, most business owners will distribute at least a percentage of their earnings back into the company.
For example, a retailer might use their profits to purchase more inventory, such as clothing and accessories. Other common examples of reinvesting profits include new product development research, marketing, and hiring more staff.
This financial metric can also be shown as a positive or negative number. A profit loss refers to a business that spent more money on operating expenses than it could earn back from customers.
Similar to cash flow, profit is broken down into three categories, including gross, net, and operating profit.
- Gross profit margin defines the revenue of a single product or service. It doesn’t take into account fixed costs such as rent or payroll. For example, let’s say you sell phone cases for $15. Each phone case costs you $5 to make. Therefore, your gross profit margin would be around 66%.
- Net profit margin refers to an organization’s profitability as a whole — not just a single product or service.
- Operating profit measures only the net profit a company earns from its typical operations. Like operating cash flow, this includes general and administrative expenses.
To learn more about the definitions and differences of these terms, read our blog post What is a Good Profit Margin?
Cash Flow vs. Profit: What’s the Difference?
Although you now understand what defines cash flow and profit, you may still be scratching your head to understand the difference between the two terms. The primary distinction is that while profit refers to the amount of money remaining after all expenses are paid, cash flow is the net flow of money coming in and out of a business.
Many new business owners are often on the hunt for one metric that defines the overall health of a company. While profit and cash flow are critical figures, the two terms are often pitted against each other to win that “best financial metric” title. However, the winner of that battle isn’t that clear cut.
Cash flow and profit are important figures in their own right. Therefore, one is not better than the other and is both necessary to track. Whether you are a small business owner, solopreneur, or investor, you’ll need to measure both profit and cash flow to effectively measure the financial health of a company
More Financial Tips, Tricks, and Best Practices
Cash flow and profit are just two of the hundreds of financial metrics, terms, and figures that small business owners should familiarize themselves with. These ratios play a major role in making informed and strategic decisions about a company.
For more business-related cheat sheets, expert advice, and product drops, visit our blog. We put an emphasis on educating small business owners and entrepreneurs about key financial principles and best practices.