Profit and Cash Flow: Key Differences
Both profit and cash flow are important indicators for your business’s financial health. Even though it is common for these terms to be confused, there’s a crucial difference between them, which every entrepreneur should know.
Keep an eye on both your profit and cash flow and fully understand the distinction between them. This will help you to better understand your business operations and to make more informed decisions about your company.
Your profit is the difference that remains from your total revenues after you subtract all your expenses. You only have profit if your inflows level is higher than your outflows.
There are multiple types of profit that give you different insights into your business. Based on the expenses subtracted from your turnover, you can calculate gross profit, operational profit and net profit. Keep in mind that your profit is determined by your invoiced amounts, which is only a promise, not actual money in your bank account.
Your cash flow is represented by daily money movements, all that you have coming in from revenue streams and going out for expenses. Your cash flow can be positive if your total inflows are higher than outflows, or negative if otherwise.
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Compared to profit, cash flow is calculated based on the actual money being transferred in and out of your business on a daily basis. It’s crucial to carefully track your cash flow because:
- You’re always up to date with your current cash available so you know if you’re able to pay your monthly expenses or not;
- You have access to your monthly cash fluctuations and you easily spot any expense that might affect your business;
- You know which is your main revenue stream and where to further invest to maximize it;
- You spot any potential cash surplus and carefully plan your next investments;
- You are fully aware of what payments can be done in the current month without risking a cash flow crisis;
- You check how sensitive is your business to seasonality and get ready for rainy days on time;
- You make informed decisions about hiring a new teammate or buying new expensive equipment.
Why keep an eye on both profit and cash flow?
Because you get access to more various data about the way your company works and therefore you’ll be able to better understand when and where to jump in to achieve your business goals.
For example, there are companies that have high profits and negative cash flow. This usually happens when even though you invoice a lot, you’re not able to successfully collect your money on time to pay your bills. The opposite version, with low profitability and a lot of cash on hand, can be seen especially in startups that have accelerated growth or in retail businesses (they cash in way before paying the suppliers).
Of course, the ideal situation is your business being both profitable and cash-flow positive. And in order to achieve this, you need to handle and keep track of your profit as well as your cash available.
Make sure you monitor the fluctuations of your profit over time, per entire business or per category of products or services, and think of how to increase your team’s performance indicators.
Always correlate your sales volume with your cash flow to make sure that you collect your money from your invoices and have enough cash on hand to pay your due bills. You cannot pay your suppliers with your profit as this is only an estimation, a promise from your clients. Cash flow is your reality check and don’t forget: it’s cash that keeps a company alive and running.
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