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What’s the difference between cash flow and profit, and why does it matter to your business?

As a business owner, tending to your cash flow and profit is one of your highest priorities. You need both to have healthy financials.

Run your BusinessFinancesBusiness

By Pipe  June 12, 2023

As a business owner, tending to your cash flow and profit is one of your highest priorities. You need both to have healthy financials. Knowing these numbers will also help you understand your company’s performance and reach your goals.

Cash flow and profit aren’t the same thing, but it’s not uncommon for business owners to mix up the two. Unfortunately, doing so can lead to costly financial mistakes.

Here, we highlight the differences between profit and cash flow—and how to accurately analyze these metrics to guide your future decisions. The short answer? It’s possible to have cash flow without profit, and vice versa. Profit means your revenue is bigger than your expenses, leaving you with something at the end. Cash flow is all about timing. Even if you earn a profit, you can have negative cash flow if you haven’t collected the cash from those sales yet. Let’s take a closer look.   

What is cash flow in business?

Cash flow is money that flows in and out of a business from operating, investing, and financing activities. It’s not the amount of cash you have left in the bank after everything is said and done—it deals with the movement of cash during a specific period. 

So, why is cash flow important? Because you can’t keep your operations running without it. Vendors don’t want to see your P&L statement, they want to be paid, which takes cash.  

Let’s start by looking at the different cash flow types.

Different types of business cash flow

Operating cash flow

Operating cash flow is the money that comes and goes directly from the production and sales of goods from normal operations. It’s also called cash flow from operations and helps determine if your company has enough cash to cover all the bills. If you see a negative cash flow from operations, it’s a sign that you may not be able to sustain your business long-term.

A few examples of operating cash flow include:

  • Employee salaries

  • Vendor payments

  • Product sales

  • Mortgage or rent payments

To calculate operating cash flow, determine how much cash you received from sales and subtract your operating expenses paid in cash during that time. You can calculate your net operating cash flow monthly, quarterly, or annually, and you’ll want to keep an eye on it regularly to anticipate any issues.

Investing cash flow

Many companies invest in securities and make other investments related to their businesses. These investments allow companies to use surplus cash and create added cash flow to fund other parts of their businesses. 

Investing cash flow also includes investments in your core business, such as research and development. A negative cash flow from investments isn’t necessarily a bad sign—especially if the investments lead to growth.

Some examples of investing cash flow include:

  • Purchase of shares in other companies

  • Investment in new technology or software

  • Expansion of manufacturing capacity

  • Investment in research and development

Financing cash flow

Cash flow from financing is cash in and out from external financing, including borrowing and repaying debt, as well as infusion of cash from equity investors. 

Examples of financing cash flow include:

  • Interest payments to lenders

  • Equity stock issued to investors 

  • Dividend payments to shareholders and business owners

  • Incoming cash from loans or investments into your company

Looking at cash flow from financing gives you a better view of how you manage your capital structure. You can see which parties (lenders and investors) are drawing cash away—which provides a starting point for reducing financing expenses (such as paying off high-interest debt). 

As you can see, investment and financing activities are an important part of running a business and can be crucial to optimizing your cash position. However, cash from these “irregular” activities can easily cover up the fact that your day-to-day business is actually operating with negative cash flow, which isn’t sustainable for very long. 

What is profit in business?

Profit is what remains of your revenue after covering certain expenses (which expenses you subtract depends on the type of profit you’re talking about; more on that in a minute). It has nothing to do with your total incoming or outgoing cash—just the difference between income and expenses.

Profits are distributed as payouts to business owners and shareholders or reinvested into the company through research, development, inventory, and marketing.

Several profit calculations can provide insights into your company’s financial health—and how each function of your business contributes to your company’s overall profit. Here are the three main types you should consider.

What are the main types of profit?

Gross Profit

Gross profit is an essential financial metric that helps businesses understand their profitability. It is the difference between revenue from sales and the costs of goods sold (COGS), excluding other fixed costs like rent and salaries. Essentially, it tells you how much money you're making after accounting for the direct expenses that went into producing or acquiring the goods or services sold.

A positive gross profit gives you something to work with to cover your operating expenses, while a negative gross profit indicates that your business is operating at a loss, even before covering your cost of doing business. It's crucial to track your gross profit over time to ensure your business is making money, and to ensure you have a healthy margin to keep operating.

Calculating gross profit is relatively simple; it involves subtracting the cost of goods sold from total revenue. However, it's essential to ensure that the COGS is calculated accurately to obtain an accurate gross profit figure. COGS should only include those costs that are directly attributable to the production of your goods or services, not indirect overhead costs. 

For example, if you run a bakery, your COGS might include ingredients, cake boxes, direct labor costs for your bakers, and supplies like parchment paper. It wouldn’t include indirect costs like your rent, your marketing expenses, or the wages of employees not directly involved in baking, like your bookkeeper.

Operating Profit

Operating profit is another crucial financial metric that tells you how much money your business is making from its core operations. It measures the profit generated by your business's operations after accounting for operating expenses, depreciation, and amortization.

Operating profit is useful because it shows how much money your business is making before considering non-operating expenses such as interest payments, tax payments, and asset sales. This provides a clear view of how much money the business is generating from its core operations and helps determine the effectiveness of your cost management strategies.

To calculate operating profit, you start with your gross profit and subtract those operating expenses you left out of the gross profit calculation—things like rent, utilities, administrative salaries, and marketing costs. 

Net Profit

Net profit, also known as the bottom line, is the profit that remains after accounting for all the expenses associated with running a business. It is the most comprehensive measure of a business's profitability, as it considers all revenue and expense streams, including taxes, interest payments, and asset sales.

Net profit shows how much money a business is making or losing after accounting for all expenses and provides a clear view of the business's financial health and profitability. It's essential to track your net profit over time to ensure that your business is profitable and to make informed decisions about allocating funds.

Calculating net profit involves subtracting all expenses from all revenue, including taxes, interest, and other non-operational expenses. A positive net profit means you have money left at the end of the year to invest in growing the business or reward owners for taking the risk of entrepreneurship, while a negative net profit means the business is losing money.

Is Cash Flow or Profit more important?

Cash flow and profit are both key ways of measuring financial health. However, they measure different aspects of a business's financial performance, and their importance depends on the business's current situation.

Cash flow measures the inflow and outflow of cash in a business, while profit measures the business's revenue and expenses. Cash flow is essential because it ensures that a business has enough cash on hand to pay its bills, meet payroll obligations, and invest in growth opportunities.

Profit, on the other hand, is important because it measures a business's overall potential to generate returns for the owner and is necessary to sustain the business in the long run. A business cannot survive on cash flow alone, and a sustained lack of profitability can lead to business failure.

Tapping into working capital to manage cash flow

Cash flow and profit work together to keep your business healthy both now and in the long run. Tapping into an external source of working capital can help you close any cash flow gaps to keep your business running smoothly and also enable you to invest in your company’s future growth and increased profitability.

Traditional bank financing can be slow and clumsy when you need fast access to capital, and bringing in cash from investors can compromise your control and ownership. Alternative options like Pipe can be the perfect solution, letting you access capital when you need it, based on your revenue and the health of your business.

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