The Difference Between Profit and Cash Flow (and How To Manage Them) (2024)

If you’re looking to start your first small business, there is one thing you need to know more than anything else, the role profit and cash flow will play in your venture.

An Insights West surveyfound that nearly half of small business owners consider these their main source of stress.

AU.S. Bankstudy by Jessie Hagan found 82% of businesses fail due to cash flow mismanagement.

We don’t want you to become part of that statistic. We want to help you start your small business on the right foot, and increase your chance of success straightout of the gate.To do that, not only do you need to ensure profits, you absolutely must embrace the concept of cash flow management and it’s critical importance to the success of your business.

Understand the Basics of Profit and Cash Flow

First things first: what do we mean when we say “profit” and “cash flow”?

In simple terms, profit is revenue minus your expenses. It is what’s left over when you subtract what it costs to run your business from what you’re charging your customers. Many small business owners, whether new or established, thinkprofit is the true measure of their enterprise’s success. It’s not. Profit is only part of the success story.

“Do not get yourself overly concerned about what your income statement is showing, or even your tax return in some cases,” sayssmall business expert and author Gene Marks. “Be more concerned [about] what your cash flow is.”

What is cash flow then?

It’s the money your business has in its bank account at any given time. It’s the cash inflows and outflows resulting from your day-to-day operations. It’s what comes in from customers paying you, and the money that goes out to pay your bills. It’s what finances your business’s day-to-day operations—paying bills, stocking inventory, subscribing to services, depositing customer payments or compensating your workers.

“It is the lifeblood of your business,” saysDenise O’Berry, author ofSmall Business Cash Flow: Strategies for Making Your Business a Financial Success. “You’ve got to have money coming in before you can put money out. That’s really what cash flow is all about: The in and out of money in your business.”

Think of profit as the theory of your business success, and cash flow as the reality. You can’t pay your electricity bill with profit, only money that’s actually sitting in your bank. Or consider a non-business example. Say your mortgage payment is due on the 15th of the month, and your paycheck gets deposited on the 31st. Now, imagine a month where you’ve had a very expensive first two weeks. Suddenly, your mortgage payment is due, and you don’t have enough money in your checking account to actually pay it. You have a cash flow issue.

Yes, your income statement may show that you earn enough to afford your mortgage. However, on that day your bill is due, you don’t have the cash on hand to pay it. (Hopefully you have a credit card or line of credit to tide you over.) When it comes to your enterprise, there’s no doubt thatlooking at profit only, even if it paints a pretty picture of your business, is exactly what trips up many small business owners. So how do you avoid being distracted by a pretty profit picture only to trip into the chasm of a cash flow crunch? Good cash flow management is the key.

Learn how to ensure you have the right amount of cash coming in at the right times to meet your the daily needs and obligations of your business – including taxes. Plus, you’ll want to include enough of a buffer to sustain operations in case of an emergency, like equipment breakdown or a plumbing problem.

Get a Solid Financial Education

Understanding the basic terms isn’t enough to ensure you can successfully navigate the tricky waters of cash flow and profit.

You have to do more of what you’re doing right now: educating yourself.

That may sound like obvious advice, but you’d be surprised by how many people don’t do it. “A lot of peoplego into business without knowing accounting, or actually not really having a good grasp on simple math, so they don’t know the difference between profits and positive cash flow,” says Marks. “If you go in there without knowing those basics of running a business you’re setting yourself up for some pretty big challenges.”

When you have a passion or great idea for a new business, we all know it can be hard to hit the brakes and study up. It may even be tempting to assume that you’ll be able to figure out the financial ins and outs of a small business as you go. You want to realize your dreams, but for your dreams to thrive, you have to protect them. That means making sure you know how to do that. Articles like this—or our guide toforecasting cash flow with spreadsheets—are excellent starting points. But you shouldalsoconsider investing the time and money to take an online or community college course. Cash flow and profit will come into play daily after you start your new business. Be sure to educate yourself before you’re up and running, so you can benefit from a firm understanding of the role profit and cash flow will play. And if you are up and still running, then it’s not too late, study up!

Use the (Software) Tools That Are Available to You

Another key way to navigate the ins and outs of profit and cash flow is knowing how to keep an eye on them. You want to be sure that, at any given moment, you know exactly how your business is doing: how much money you’ve invoiced, how much you’ve received, and if it’s enough to pay your bills on time.

Again, you’d be surprised how many folksdon’t help themselves by keeping an eye out for that.A survey by Wasp Barcode Technologiesfound that over half of small business owners do not track their assets. There’s no excuse for that, especially when resources like accounting software programs—such as QuickBooks, Xero, FreshBooks, Wave, Sage, and Zoho—exist to empower small business people to grasp their financial situations.

Use the tools available to you (including our owncash flow calculator) and be sure to pick ones that are comprehensive as possible – capable of giving you both the big picture and the daily update of your finances.

All that being said, don’t let those programs tempt you into thinking you don’t need to educate yourself. Software, however valuable, is no replacement for financial know-how.

“Like any tool, they’ve got to be put in the hands of somebody who knows what to do with them,” Marks says. “It still does not relieve you of your responsibility to get an education in accounting and cash flow if you’re going to run a business.”

Never Forget About Uncle Sam

If a new small business owner doesn’t do their homework, there is a season every year, when they will see the dramatic difference between profit and cash flow: tax time.

That’s when many discover it’s possible to be profitable but cash poor at the same time. And that’s because they mismanaged their cash flow by, for example, overspending on inventory, or failing to collect money from their customers.

“The thing that I see over and over again is people in a business that is actually making a profit, and when it comes time to pay taxes, and they say, well, ‘How can I owe taxes? Because I don’t have any money,'” saysCaroline Grimm, author ofStop the Cash Flow Roller Coaster.

For every dollar of profit, you get taxed. If you don’t put that money aside and protect it (ideally, in a dedicated bank account younevertouch), you can easily find yourself not having the money you need when Uncle Sam holds his hand out.

That’s another reason why understanding cash flow is so important: you’ll know that just because your business shows it made a certain amount of money on paper, that doesn’t mean you actually have it on hand.

Know Which Customers to Pick for Your Business

Once you understand the significance of cash flow to your business, something becomes clear very quickly. “One of the keys to being successful in business and having a healthy cash flow: targeting the right customer,” says O’Berry.

If you don’t get paid, you have no cash to run your business. Yes,better invoicing can improve your cash flow, but ensuring you have ideal customers is especially important.

That can mean doing credit checks first, making them agree to pay all invoices in three days, or using PayPal payments. Do whatever you need to do in order to ensure your cash flow is protected.

What if a customer resists, and wants the standard “Invoice after 30 days. Pay after another 30 days” arrangement? Consider adding a premium so you get more money when they do finally pay.

Or you could entice them by doing the opposite and offer a discount for quicker payments. It may lose you a little bit of money, but that can be worth what you get in exchange: reliability.

Cultivating a customer base whose payments you can depend on will do wonders for your cash flow, your business, and your life. “From the beginning, you want to set a precedent and say, ‘This is how it’s going to be.’ It will save you so much money and heartache and stress,” saysMichelle Dunn, author ofThe Guide to Getting Paid.

Don’t Be Afraid to Learn From Failure

It’s a hard truth that even if you manage all of the above, once you start your small business, you may face times when cash flow will be tight – possibly because you made a mistake. But know this: that’s okay.A survey by Fifth Third Bankfound that 4 out of 10 small business owners didn’t have enough cash to meet their business goals, so you’re not alone.

That’s not all.

“It’s at that moment [when money is tight]that you suddenly realize the true importance of bringing cash in,” says Marks. “Sometimes you’ve just got to be living it to really learn it, and that’s how the lesson sinks in.” That can be incredibly valuable. What’s more, that experience can teach you what you can’t learn practically: the greater importance of cash flow.

“What your cash flow is, is the story and health of your business. It can tell you over time what’s successful, what’s not so successful,” says O’Berry. Understanding profit and cash flow then allows you to control the story of your business. Even better, it gives you a better chance of writing a happy ending for it.

Next Steps:You’re busy. We get it. So why not let us do some work for you? By signing up for the weeklySmall Biz Ahead Newsletter, you’ll receive handpicked articles, how-tos and videos covering the latest in small biz tools and trends. We’ll do the research while you spend your time where it counts: learning how to navigate cash flow and profit so you can grow your business.

The Difference Between Profit and Cash Flow (and How To Manage Them) (1)Next Steps:You’re busy. We get it. So why not let us do some work for you? By signing up for the weeklySmall Biz Ahead Newsletter, you’ll receive hand-picked articles, How-Tos and videos covering the latest in small biz tools and trends. We’ll do the research while you spend your time where it counts: managing and growing your business.

I bring a wealth of expertise in the realm of small business management, particularly in the areas of profit, cash flow, and financial strategies. My insights are grounded in practical knowledge, and I've successfully navigated the challenges that many small business owners face. Now, let's delve into the concepts mentioned in the article.

Profit and Cash Flow: The article rightly emphasizes the critical role that profit and cash flow play in the success of a small business. Profit, as defined, is the revenue minus expenses, representing what remains after covering the costs of running the business. However, the article stresses that profit alone is not the true measure of success; rather, cash flow takes center stage.

Cash Flow: Cash flow is described as the money a business has in its bank account at any given time. It encompasses the inflows and outflows resulting from day-to-day operations, including payments from customers and expenses. The analogy of cash flow being the lifeblood of a business aptly captures its importance, as it funds daily operations, from paying bills to compensating workers.

Cash Flow Management: The article emphasizes the importance of good cash flow management, stating that looking only at profit can lead to pitfalls. It advises ensuring the right amount of cash is coming in at the right times, covering daily needs, obligations, and creating a buffer for emergencies.

Financial Education: A strong call for a solid financial education is made, highlighting the need for business owners to understand accounting and the basics of running a business. The article suggests investing time and money in courses to grasp the intricacies of cash flow and profit, emphasizing that education is crucial before or during the operation of a small business.

Utilizing Tools: The article recommends leveraging available tools, including accounting software programs like QuickBooks, Xero, FreshBooks, and others, to keep track of financial situations. However, it underscores that these tools should complement, not replace, the need for financial know-how.

Tax Implications: The article warns about the potential cash flow challenges during tax time. It points out that being profitable on paper doesn't guarantee having the necessary funds to meet tax obligations, emphasizing the importance of setting aside money for taxes.

Customer Selection: Choosing the right customers is highlighted as a key factor in maintaining healthy cash flow. The article suggests doing credit checks, setting payment terms, and even offering discounts or premiums to ensure reliable payments.

Learning from Failure: Acknowledging that tight cash flow situations may arise, the article encourages learning from failure. It mentions that experiencing challenges can provide valuable lessons, especially in understanding the true importance of cash flow.

In summary, the article provides a comprehensive guide for small business owners, emphasizing the interconnectedness of profit and cash flow and offering practical advice on financial education, tool utilization, tax awareness, customer selection, and learning from challenges.

The Difference Between Profit and Cash Flow (and How To Manage Them) (2024)

FAQs

The Difference Between Profit and Cash Flow (and How To Manage Them)? ›

Indication: Cash flow shows how much money moves in and out of your business, while profit illustrates how much money is left over after you've paid all your expenses. Statement: Cash flow is reported on the cash flow statement, and profits can be found in the income statement.

What is the difference between cashflow and profit? ›

So, is cash flow the same as profit? No, there are stark differences between the two metrics. Cash flow is the money that flows in and out of your business throughout a given period, while profit is whatever remains from your revenue after costs are deducted.

How do you manage profit and cash flow? ›

8 ways for small business owners to manage their cash flow
  1. Know when you will break even. ...
  2. Put cash-flow management before profits. ...
  3. Secure credit ahead of time. ...
  4. Use a dedicated software to manage your finances. ...
  5. Use a payroll service. ...
  6. Accounts payable improvements. ...
  7. Schedule your payments. ...
  8. Keep up on cash coming in.
Jan 24, 2024

What is cash flow and how do you manage it? ›

Cash flow is a measurement of the amount of cash that comes into and out of your business in a particular period of time. When you have positive cash flow, you have more cash coming into your business than you have leaving it. When you have negative cash flow, the opposite is true.

How profits and cash flow are different in very basic terms? ›

The Difference Between Cash Flow and Profit

The key difference between cash flow and profit is while profit indicates the amount of money left over after all expenses have been paid, cash flow indicates the net flow of cash into and out of a business.

Why use cash flow instead of profit? ›

Cash Flow Helps With Business Growth

A steady, positive cash flow that is invested to expand your business is a far superior strategy than simply hanging on to small profits. Instead, growth due to continual cash flow can lead to heavy profits in future. It's a sign of the long-term prosperity of the organization.

How can you be cash flow positive but not profitable? ›

If a company sells an asset or a portion of the company to raise capital, the proceeds from the sale would be an addition to cash for the period. As a result, a company could have a net loss while recording positive cash flow from the sale of the asset if the asset's value exceeded the loss for the period.

How do you manage poor cash flow? ›

9 cash flow strategies
  1. Don't wait to send invoices. ...
  2. Adjust your inventory as needed. ...
  3. Lease your equipment instead of buying it. ...
  4. Borrow money before you need it. ...
  5. Reevaluate your business operations. ...
  6. Restructure your payments and collections. ...
  7. Monitor where your money is going. ...
  8. Take advantage of technology.
Apr 11, 2024

What is a healthy cash flow? ›

A healthy cash flow ratio is a higher ratio of cash inflows to cash outflows. There are various ratios to assess cash flow health, but one commonly used ratio is the operating cash flow ratio—cash flow from operations, divided by current liabilities.

How to improve cash flow in a business? ›

6 ways to improve cash flow in your business
  1. Use software to track your inflows and outflows. ...
  2. Send invoices out immediately. ...
  3. Offer various payment options for customers. ...
  4. Reduce operating costs. ...
  5. Encourage early payments, while discouraging late payments. ...
  6. Experiment with your prices.

How can cash flow be positive? ›

If a business's cash acquired exceeds its cash spent, it has a positive cash flow. In other words, positive cash flow means more cash is coming in than going out, which is essential for a business to sustain long-term growth.

What is the difference between cash flow and profit and loss statement? ›

Both concepts are important parts of a successful financial planning. Cash flow is important because it shows how much money a business has available to meet its obligations. Profit and loss, on the other hand, is a measure of whether a business is making money or not.

What is cash flow in simple terms? ›

Cash flow is the net cash and cash equivalents transferred in and out of a company. Cash received represents inflows, while money spent represents outflows.

What is an example of a cash flow? ›

What is a cash flow example? Examples of cash flow include: receiving payments from customers for goods or services, paying employees' wages, investing in new equipment or property, taking out a loan, and receiving dividends from investments.

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