What is the difference between profit and cash flow?

To run a successful business, two of the most important parts of business finances that you need to understand are cash flow and profits.

This guide helps you understand how these two elements work by answering the following questions:

• What is the difference between profit and cash flow?
• What do cash flow and profit tell you about your business?
• How do income and expenses affect profit and cash flow?
• Cash flow vs profit: which is more important to your business?

Whether you’re a freelancer or a small business owner, Countingup can help you understand and manage your finances better.

Cash flow and profit both say a lot about how your company is performing. While both components are important, cash flow is probably the number one concern for small growing businesses. Here’s why:

Profits don’t give you the whole picture of your company’s financial status since it doesn’t show when money flows in and out of your business. In other words, you can’t tell how your business is doing financially by only looking at profits. 

Cash flow gives you a clearer view because it shows you when those inflows and outflows happen. Knowing when your company sends and receives cash allows you to determine if it has enough funds to survive long term. You can read more about how to create a healthy cash flow ratio in this guide. 

We’ve broken both parts down below to give you a better idea of what they entail. 

Cash flow refers to how money moves in and out of your business. The money you make is called your cash inflows and the money you spend is called outflows.

In a business, cash flow mainly comes from these three categories:

• Operating cash flow: Money you make from day-to-day business operations that show whether you have enough funds coming in to pay your bills and expenses.
• Investing cash flow: Money from investment-related activities, such as investments in securities or buying physical assets like equipment or property.
• Financing cash flow: Money that moves between your company and its investors, owners, or creditors. Financial cash flow may include debt, equity, and dividend payments.

When a business doesn’t have enough cash flow, it won’t be able to meet its financial obligations like paying bills, investors, or suppliers. You can find out everything you need to know about cash flow in this guide. 

Profit, also known as net income, is the money you have left from sales revenue (money you make from sales) after you’ve paid off your financial obligations like bills, licence fees and loan repayments. There are two main types of profit:

• Gross profit – The profit your company made after deducting costs directly linked to selling your goods or services, such as supplies or equipment.
• Net profit – The profit made by your company after deducting all other costs, including taxes and operating expenses like rent and payroll.

While increasing your profits benefits your company’s bottom-line (income after all expenses have been deducted from revenues), it’s essential to understand how profit affects your cash flow. 

For example, a new source of profitability, like offering a new product, may increase your expenses if you have to buy new supplies or spend more on marketing. You could end up pushing your expenses past the breakeven point (where you make as much as you spend). As a result, you could end up running out of money. 

Cash flow and profit depend on income (money you receive from sales or investments) and expenses (what you spend on bills, salaries, accounts payable). However, how income and expenses affect these two components is different. 

For example, your company can have a positive cash flow (where you make more than you spend) without making any profit. This happens if the cash comes from other sources than income, like if you take out a loan to fund your new product launch. These transactions count as liabilities (money you owe) rather than profit. 

Your company can also have negative cash flow (spending more than you make) while making a hefty profit. For instance, if you take out cash from the company to pay personal expenses or loan money to others. On the flip side, if your business has a positive cash flow without making a profit, you may struggle to stay cash positive for long.

As two critical and related financial components, cash flow and profit may get pitted against each other, but which is more important? 

There is no simple way to determine which has more value since both cash flow and profit are crucial in their own way. Whether you’re a sole trader or a small company owner, you need to understand both metrics and how they interact with each other. You need this knowledge to evaluate the genuine financial health of your business.

As we’ve mentioned, you can be profitable and still have a negative cash flow preventing you from paying your expenses. You can also generate positive cash flow without making a profit, which is the case for many startups and growing businesses. 

Simply put, profit and cash flow are equally important to a company’s long-term success. Profit is the goal and indicates your financial health, but cash flow is the lifeblood of your business that keeps it going. 

Make payments, get cash flow insights, tax estimates and more by signing up to a Countingup business current account. 

Managing your cash flow can be done easily with the right system. Countingup’s business current account and accounting app provides real-time insights into your finances and cash flow management to keep your business running like clockwork.

Find out more here.