Cash flow a continuous movement of cash in and out of the business.
Profit the positive difference between a firm’s total sales revenue and its total costs of production. When a sale is made, this contributes towards paying the firm’s costs. Any sales beyond breakeven is profit.
Be careful: cash is not just cash (i.e., physical banknotes and coins) but also everything that can be expressed in form of cash, such as sales, bank loans, over heads, tax, insurance etc.
Note: cash flow and profit is not the same thing! Profit is calculated as total revenue minus total costs. Cash flow represents all the cash going in and out of the business.
Frequently Asked Questions: Cash Flow vs Profit
What is the difference between Cash Flow and Profit?
While both relate to a business's financial health, **Profit** (specifically Net Profit or Net Income) represents the excess of revenues over expenses during a period, as reported on the Income Statement. It's an accounting measure based on the matching principle, where revenues and expenses are recorded when earned or incurred, regardless of when cash changes hands.
**Cash Flow**, on the other hand, represents the actual movement of cash into and out of a business during a period, as reported on the Statement of Cash Flows. It tracks the liquidity of the business – whether it has enough cash on hand to cover its obligations and operations.
In simple terms: **Profit is theoretical income; Cash Flow is actual cash movement.**
Can a business be profitable but have negative cash flow?
Yes, this is a common situation, especially for growing businesses. Reasons include:
- **High Accounts Receivable:** Sales are made and recorded as revenue (contributing to profit), but customers haven't paid yet (no cash received).
- **Inventory Buildup:** Cash is spent to purchase or produce inventory, but it hasn't been sold yet (cash outflow, but no expense recognized until sold).
- **Large Capital Expenditures:** Significant cash is spent on long-term assets (like machinery or buildings), which are capitalized on the balance sheet and depreciated over time (impacting profit slowly), but represent a large immediate cash outflow.
- **Paying Down Debt:** Cash is used to repay loan principal (a cash outflow), but this doesn't impact profit directly (only the interest portion of the payment is an expense).
Can a business have positive cash flow but be unprofitable?
Yes, this can also happen. Reasons include:
- **Selling Assets:** Receiving cash from selling long-term assets (cash inflow), but potentially incurring a loss on the sale (impacting profit negatively).
- **Taking on New Debt:** Borrowing money brings cash into the business (cash inflow), but increases liabilities and doesn't impact current profit.
- **Delaying Payments:** Stretching out payments to suppliers (Accounts Payable) keeps cash in the business longer (cash inflow relative to when expense was incurred), but the expense has already reduced profit.
- **Collecting Old Receivables:** Receiving cash from sales made and recorded as revenue in a prior period (cash inflow, but no impact on current period's profit).
Which is more important: Profit or Cash Flow?
Both are crucial, but in the short term, **cash flow is often considered more critical for survival**. A profitable business can still fail if it runs out of cash to pay employees, suppliers, or lenders. Profitability indicates the underlying earning power, but cash flow indicates the business's ability to meet its immediate and short-term obligations and fund operations. In the long run, a business generally needs to be profitable to generate sustained positive cash flow.
What about Free Cash Flow vs Net Profit?
**Net Profit** is the "bottom line" from the Income Statement. **Free Cash Flow (FCF)** is a measure of the cash a company generates after accounting for cash outflows to support operations and maintain its capital assets (like property, plant, and equipment). FCF is generally considered a more accurate picture of the actual cash available to a company after investments needed for ongoing operations. It's calculated starting from operating cash flow and subtracting capital expenditures (CapEx).
