Understanding the difference between profits and cash flow

As a small business owner, you’ve likely heard the terms “cash flow” and “profits” used interchangeably. However, mixing these financial metrics up can cause severe consequences for your business.

The distinction between the two can significantly impact your business’s financial health and your decision-making process.

Here is a quick guide to cash flow and profits so you can avoid confusing the two.

What are profits?

Profits are the surplus that remains after all expenses have been deducted from your income.

If you have worked out a solid business model (and consulted a good accountant), you should be able to see profits on your bookkeeping records.

However, profits on paper do not always translate to available cash in your bank account.

What is cash flow?

Cash flow is the net amount of cash moving in and out of your business.

Positive cash flow means you have more cash coming in (from sales and other inputs) than going out (in operational costs or salaries, for example).

Equally, negative cash flow is the opposite – more money flowing out of the business than coming in.

Unlike profits, cash flow reflects the liquidity of your business at any given time.

What are the key differences between profit and cash flow?

Profits are recorded on an accrual basis, meaning they count as soon as the transaction is made, irrespective of when the cash is received.

Cash flow, on the other hand, counts money when it actually enters or leaves your bank account making it a more accurate metric for measuring how much cash you have available to spend.

Profit calculations also often include non-cash items like depreciation or amortisation. Unfortunately, these figures can distort your perception of actual cash in hand.

Positive cash flow allows your business to make investments in new opportunities without relying on external financing.

Profits, even if high, can be tied up in receivables or inventory and may not be readily accessible. A high cash flow means that access to cash is easier, which is not always the case with profits.

Why they are both important 

Profit and cash flow may be different, but both are of huge importance to your business:

• Strategic planning: Understanding your profit margins can aid you with long-term strategic planning and assessing the viability of new projects. Your profits are an indicator of whether your business can grow and sustain itself in the long run.
• Day-to-day operations: Positive cash flow ensures that you can cover your immediate expenses, like payroll and inventory purchases, without dipping into credit or external funding.
• Investor and lender attractiveness: Both cash flow and profit metrics are critical for stakeholders. While profits often make you more attractive to investors, lenders frequently look at cash flow to gauge your ability to repay loans.

Understanding these two critical metrics, means you are better equipped to make informed decisions that contribute to your business’s long-term success and stability.

Butterworth Barlow: Here to boost your business health

Both profits and cash flow are both important indicators of the financial health of your business.

However, they serve very different purposes, and confusing the two can be costly.

Our team of friendly, approachable accountants can help you keep both in good shape.

Alongside our annual and management accounts preparation, we offer cash flow forecasting services and clear, tailored business advice to help you meet your financial goals.

Whichever stage you’re at, we’re here to streamline your accounting and keep your business in good health,

For further advice and guidance on managing your profits and cash flow, please get in touch with our friendly team today.