If you’re like 61% of small business owners, you struggle regularly with cash flow.

Even if your company is profitable, you can still be at risk of falling into financial demise. How? If you don’t have enough liquid cash (cash flow) on hand to meet the myriad of expenses that come with owning a small business, it can be nearly impossible to keep your long-term financial situation, not to mention your business, afloat. 

Many business owners don’t truly understand what cash flow is as opposed to profit, so that’s what we’ll cover in this article.

Cash Flow Versus Profit

Cash flow refers to the money that flows in and out of your business. It’s income and expenses. What you’re bringing in and spending. Profit, however, is the money you have after deducting your business expenses from overall revenue. Both are important, but cash flow is essential to keep your business running in the here and now.

Now let’s dive deeper into each of these so you have a better understanding of the role that cash flow and profit hold in your business.

What Is Cash Flow?

Cash flow is essentially the cycle of funds going in and out of your business bank account from operations, investing, and financing activities. It’s the amount of cash that you have at your disposal at any given time. Your business can either be cash flow positive or cash flow negative.  

Positive cash flow occurs when the ratio of cash inflows is greater than your cash outflows, or when there is more cash coming into your account than you are spending. 

Negative cash flow happens when your cash outflows are greater than your cash inflows. You are spending more than you are bringing in.

Examples of cash inflows are:

• Money coming in from accounts receivable
• The sales of services and products
• Borrowed capital like lines of credit or small business loans 

You’d see these on your income statement.

Cash outflows are any debts, liabilities, or operating costs that running your business may incur. Examples of cash outflows (also known as cash outlay) are:

• Money going out for accounts payable
• Payroll, taxes
• Inventory
• Rent
• Loan payments
• Other business expenses

If you decided to borrow $75,000 in equipment financing, the lump sum of capital you would receive upfront would be considered part of your cash inflows, and your payments on the loan would be considered among your cash outflows.

What is Profit? 

Profit (also known as “net profit” or “net income”) is the amount of money that remains after all expenses — including cost of goods sold (COGS), as well as operating costs, interest payments, loan payments, and taxes — are deducted from your revenue. 

To figure out your total profitability, you need to understand both gross profit and net profit.

Gross profit is the difference between your income and the total cost of goods sold. For example, let’s say you own a flower shop. You bring in $25,000 in revenue in April, but your cost of goods sold (i.e. wholesale flowers) amounts to $10,000. Your gross profit would be $15,000. 

Revenue – Cost of Goods Sold (COGS) = Gross Profit 

$25,000 – $10,000 = $15,000

Another number here that can be helpful is your gross profit margin. If you take your gross profit ($15,000) and divide it by your revenue ($25,000), you arrive at .6, or 60% profit margin. That’s pretty great! This tells you how well your business is doing financially.

Your gross profit is what you make from selling your inventory of flowers, but it does not account for all the other operating expenses that are involved in running your flower shop. For example, the cost of rent, electricity, payroll, and advertising are all expenses that you need to pay for with your gross profit. Factoring in your operating expenses, which we’ll say were $5,000, your net profit for April would be $10,000. 

Gross Profit – Operating Expenses = Net Profit (or Net Income) 

$15,000 – $5,000 = $10,000

When it comes to financial statements, you’d identify your gross and net profit on the profit and loss statement.

While profitability provides you with a snapshot of your financial situation during a specific period of time in your accounting, it fails to account for the day-to-day stability of your operation. That’s where net cash flow comes in.

What’s the Difference Between Cash Flow and Profit? 

While being cash flow positive and profitable may seem pretty much the same at first glance, there’s a key difference that is important to understand.

To function, you need operating cash flow to meet payroll, make rent and insurance payments, and handle the laundry list of other day-to-day expenses to keep business running as usual. 

Many businesses use the accrual method of accounting, which records income and expenses when you earn or incur them — regardless of whether the cash has actually been exchanged. 

If you’re sending out invoices to clients that may not pay those invoices for 30, 60, 90, or even 120 days, your real-time cash flow situation will look very different than your profitability — and you may find yourself without enough liquidity to keep your company running. 

Let’s use a single invoice to illustrate this point. You land a huge opportunity with a wedding planner, who needs $15,000 worth of arrangements for an upcoming wedding. You invoice the customer on May 1 with a deadline of 60 days. You also have to pay your vendor $8,000 for the inventory (flowers) within the next 30 days.

Without factoring in your operating expenses for this transaction, your profit for May would be $7,000 — not bad at all!

But, this fails to give you a clear picture of your cash flow because you might not get paid that $15,000 until after your $8,000 invoice for the flowers is due. That’s where the cash basis of accounting comes in. While used less commonly, it is important for gauging how much cash you actually have on hand, as revenue and expenses aren’t actually recorded until the money is exchanged. With terms of net-60, you wouldn’t actually receive the money until July 1. See below: 

	May 1	June 1	July 1
Inflow	$0	$0	$15,000
Outflow	$0	$8,000	$0
Net Cash	$0	-$8,000	$7,000

Which One is More Important to a Business: Cash Flow or Profit?

The truth is: both cash flow and profit are important. It’s not an apples-to-apples comparison. While profitability is more important over time, cash flow and the availability of working capital are going to affect your daily operations and short-term finances.

There are profitable businesses that go under every year because they have poor cash flow. If you don’t have cash on hand to cover your expenses, being profitable in the bigger picture isn’t going to do you much good.

Forecasting Cash Flow

Cash flow forecasting can help you better understand the ebbs and flows of money in and out of your bank account and can help you make smart financial decisions to ensure you don’t suffer a cash crunch. 

You might learn, for example, that while you offer net-60 terms to clients, most of your vendors offer only net-30, which means you won’t always have funds to pay your invoices. You have a few options here: you could pull back to net-30 terms for your clients in an effort to align positive and negative cash flow, or you could explore business financing options that would put money in your account so you can cover your expenses on time.

You could, for example, take out a line of credit that lets you access cash when you need to pay expenses but don’t have the money to cover them. Then, when your clients do pay you, you can pay back what you’ve borrowed.

Nav’s Final Word: Cash Flow vs. Profit

While we went through a simplified example with a single invoice, if you’re sending out multiple invoices with different payment terms while managing the day-to-day operational expenses, you may see how staying out of the red could get tricky. 

That’s why it’s so crucial for small business owners to not only understand the difference between cash flow vs. profit, but also figure out better ways to increase cash flow. Cash flow management can help your company better predict when you’ll have money in the bank and strategize to ensure you never have to make financial decisions out of desperation. A profitable business is one who not only realizes an overall profit but who also successfully manages daily cash flow.

If you’re looking for ways to increase your cash flow through business financing or  business credit cards, Nav can show you options you’re likely to qualify for based on your business credit scores and other data. Sign up for a free account today to start seeing your options. 

Frequently Asked Questions About Cash Flow and Profit and Loss Statements

• Is cash flow seen on the profit and loss statement?

  While a cash flow statement is different from a profit and loss (P&L) statement, the two reports are linked. Most P&L statements include net profit or loss in the first line of the report, which is what cash flow calculates. You can determine your cash flow from a P&L statement by adding depreciation and net income and then subtracting change in change in working capital and capital expenditure.

• What elements make up a profit and loss statement?

  A profit and loss (P&L) statement is made up of several line items that document your sales amounts (revenue) and expenses. What line items make up your P&L will depend on your business. At its most basic, a P&L will include: 
  – Net sales (revenue)
  – Cost of goods sold (COGS)
  – Gross margin
  – Selling, general, and administrative (SG&A) expenses or operating expenses
  – Net income or profit
  – Taxes
  
  Your business may also have other expenses, such as:
  – Interest expenses
  – Marketing and advertising
  – Technology or research and development (R&D)

• What elements make up a cash flow statement?

  There are three main elements of a cash flow statement: 
  – Business operations
  – Investing
  – Financing
  Operations is the most basic form of revenue for a business and comes from your sales of goods and services. Investing includes any money you’re making off of investments such as the stock market or real estate. Financing is any money that comes from business loans, lines of credit, merchant cash advances, equipment financing, etc.