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Cash flow and profit are essential financial metrics in business. Yet, it isn’t uncommon for those new to finance and accounting to occasionally confuse the two terms. Cash flow and profit aren't the same things, and it’s critical to understand the difference between them to make key decisions regarding a business’s performance and financial health. For investors, understanding the difference between profit and cash flow makes it easier to know whether a profitable company is a good, long-term investment based on its ability to remain solvent in times of economic crisis. For entrepreneurs and business owners, understanding the relationship between the terms can inform important business decisions, including the best way to pursue growth. Here’s everything you need to know about cash flow, profit, and the difference between the two concepts. Access your free e-book today. DOWNLOAD NOWWhat is Cash Flow?Cash flow refers to the net balance of cash moving into and out of a business at a specific point in time. Cash is constantly moving into and out of a business. For example, when a retailer purchases inventory, money flows out of the business toward its suppliers. When that same retailer sells something from its inventory, cash flows into the business from its customers. Paying workers or utility bills represents cash flowing out of the business toward its debtors. While collecting a monthly installment on a customer purchase financed 18 months ago shows cash flowing into the business. The list goes on. Cash flow can be positive or negative. Positive cash flow means a company has more money moving into it than out of it. Negative cash flow indicates a company has more money moving out of it than into it. Types of Cash Flow
Related: Financial Terminology: 20 Financial Terms to Know The Cash Flow StatementCash flow is typically reported in the cash flow statement, a financial document designed to provide a detailed analysis of what happened to a business’s cash during a specified period of time. The document shows different areas where a company used or received cash and reconciles the beginning and ending cash balances. Go to the alternative version. What Is Profit?Profit is typically defined as the balance that remains when all of a business’s operating expenses are subtracted from its revenues. It’s what's left when the books are balanced and expenses are subtracted from proceeds. Profit can either be distributed to the owners and shareholders of the company, often in the form of dividend payments, or reinvested back into the company. Profits might, for example, be used to purchase new inventory for a business to sell, or used to finance research and development (R&D) of new products or services. Like cash flow, profit can be depicted as a positive or negative number. When this calculation results in a negative number, it’s typically referred to as a loss, because the company spent more money operating than it was able to recoup from those operations. Types of Profit
The Income StatementInformation about a company’s profits is typically communicated in its income statement, also known as a profit and loss statement (P&L). This statement summarizes the cumulative impact of revenue, gains, expenses, and losses over the course of a specified period of time. Go to the alternative version. The Difference Between Cash Flow and ProfitThe key difference between cash flow and profit is while profit indicates the amount of money left over after all expenses have been paid, cash flow indicates the net flow of cash into and out of a business. Which Is More Important: Cash Flow or Profit?Investors and business owners are often in search of a single metric for understanding the health of a company. They want one line item in a financial statement to determine whether they should make an investment or pivot their business strategy. In these instances, cash flow and profit are often pitted against each other. But which is more important? There isn’t a simple answer to that question; both profit and cash flow are important in their own ways. As an investor, business owner, employee, or entrepreneur, you need to understand both metrics and how they interact with each other if you want to evaluate the financial health of a business. For example, it’s possible for a company to be both profitable and have a negative cash flow hindering its ability to pay its expenses, expand, and grow. Similarly, it’s possible for a company with positive cash flow and increasing sales to fail to make a profit—as is the case with many startups and scaling businesses. Profit and cash flow are just two of the dozens of financial terms, metrics, and ratios that you should be fluent in to make informed business decisions. By gaining a thorough understanding of key financial principles, it’s possible to advance professionally and become a smarter investor or business owner. Are you interested in gaining a toolkit for making smart financial decisions and the confidence to clearly communicate those decisions to stakeholders? Explore our online finance and accounting courses and discover how you can unlock critical insights into your organization’s performance and potential. This post was updated on April 19, 2022. It was originally published on April 21, 2020. Data TablesCompany A - Statement of Cash Flows (Alternative Version)Year Ended September 28, 2019 (In millions) Cash and cash equivalents, beginning of the year: $10,746 OPERATING ACTIVITIES
INVESTING ACTIVITIES
FINANCING ACTIVITIES
Increase / Decrease in Cash and Cash Equivalents: 3,513 Cash and Cash Equivalents, End of Year: $14,259 Go back to the article. Company B - Annual Trial Balance (Alternative Version)September 28, 2019 (In thousands)
Company B Income StatementFor Year Ended September 28, 2019 (In thousands)
Go back to the article.
Tim Stobierski is a marketing specialist and contributing writer for Harvard Business School Online. |