Business owners across every industry are unified by a single objective: generate enough revenue from sales to cover expenses and have some, if not a substantial amount, left over. This is the simplest definition of profit and the for the majority of businesses, it represents the most important metric of an organization’s success. However, a critical component of business success also comes by way of positive cash flow—the ongoing influx and outflow of money from business operations. Although cash flow and profit are often used interchangeably, the terms are far from the same. Whether you’re a first-time entrepreneur or a well-established company, knowing the difference between cash flow versus profit is critical to sustaining your business.
Understanding cash flow versus profit
The significance of cash flow
On any given day, businesses earn cash from the sale of products or services and pay out cash to cover operating expenses. The difference between the two results in either positive or negative cash flow—the true measure of how a company is performing. For some businesses, cash flow is relatively steady day to day or month to month; for others, like SaaS companies or seasonal ventures, cash flow is far from consistent.
For example, cash flow may be high in periods right after a new product launch or a renewal of subscriptions, creating the opportunity to buy more inventory or increase spending on marketing efforts. When cash flow is tight, however, businesses may need to pull from reserves or tap into a line of credit to satisfy outstanding bills. Organizations must have an intimate understanding of operational cash flow in order to avoid running into devastating shortfalls or overspending, both of which ultimately eat into profits.
So, what about profit?
A profitable business is one that carries a positive balance on the books after all expenses are paid. This differs from cash flow in that profit paints a picture of the overall financial health of the organization for a moment in time, as opposed to detailing the timing of cash in and outflows in a specific month or quarter. In analyzing an organization’s financial stability, understanding the relationship between the two is key. A business can be profitable without having strong cash flow, but a lack of cash-flow management can lead even a profitable business to an early and unnecessary demise.
How one affects the other
Businesses have the ability to boost cash flow without affecting profit. lf you find that you need to increase your cash flow in order to continue your growth trajectory, you may consider bootstrapping cash from the internal stakeholders or talking to outside investors. If you want to keep your equity, you may consider using a line of credit or loan to help you manage operational costs. On the flip side of that coin, figures on the income statement can show profits but not affect cash flow. Accounts receivable write-offs positively affect profits but don’t move the cash-flow needle. Analyzing both profit and cash flow is the true test of a company’s viability over time.
Businesses need profits to invest in growth opportunities such as acquiring additional inventory, hiring new talent, investing in new marketing campaigns, and developing new or enhanced products and services. However, a company that is deemed profitable but lacks manageable cash flow can struggle to keep its doors open. Fortunately, there are methods to mitigate cash-flow issues that subsequently help on the profit side of the business:
- Pay close attention to accounts receivable and collection times, and work toward receiving timely payment
- Manage inventory ordering in line with sales history to avoid overspending on products that may not move quickly
- Forecast cash flow regularly, analyze projected figures versus actual results, and course correct when necessary
- Establish a safety net for slow cash-flow periods (based on forecasts)
Creating and sustaining a profitable business is the ultimate objective, but managing cash flow is just as, if not more important to ongoing success. For more information on how to manage cash flow, check out our suggestions for getting your SaaS company to cash flow positive, or our tips for managing seasonal cash-flow fluctuations.