The Difference Between Cash Flow and Profit

We sometimes get the question, “What’s the difference between cash flow and profit?” I have even had the statement: “I can’t be profitable because there’s no money in my bank.”

So, what is the difference between cash flow and profit in simple terms?

Profit is what is left over after you earn your income and pay your expenses. Cash flow, on the other hand, is the movement of money in and out of the business.

So, profit is looking at the products you sell, the cost of goods for making those products, and your overhead and expenses, and the leftover amount is your profit.

Cash flow could have money coming in from loans, accounts receivable, or sales, and your payments out could be reducing liabilities, purchasing fixed assets or other such expenses.

So, as you can see, cash flow and profit are two totally different things, yet they do work together.

These two terms are not interchangeable.  Your business can look profitable, but not have cash in the business.   This could be due to several situations.

1. You bought a large piece of equipment on credit in the past and are currently paying on the loan. Payments to reduce a liability do not reduce profit. However, the cash was spent reducing the money available to the business.

2. You drew money out of the business as payments to yourself. These are not expenses of the business but rather a reduction of equity. Therefore, profit remains the same, but cash is reduced.

3. You file your tax returns on an accrual basis (income is counted when the client is invoiced whether payment has been received or not) but the clients haven’t yet paid.

 On a similar note, your business can be operating at a loss, but you could have money in the bank.  This could be because:

1. You invested money into the business (increase in equity), but the sales aren’t high enough to offset incurred expenses resulting in a loss

2. You received a loan for operating capital (liability) but expenses are still higher than income from sales

3. You sold equipment (increasing cash on hand) but it wasn’t inventory sold to a customer to increase income

It’s important to watch both profit and cash flow to truly understand what is happening in your business.  Review your reports often to see where adjustments need to be made to reduce expenses, increase income, and keep enough money in the bank to cover expected outflows.

Need help with your bookkeeping?  We can help.  Contact us today at contact@abandp.com or 310-534-5577.  We’ll be glad to assist you!