profit vs cash flow

If you’re new to cash flow forecasting you may be wondering what’s the difference between cash flow and profit? 

To answer this question let’s quickly cover some basics. 

What is Cash Flow?  

Cash flow refers to the net amount of inflows and outflows of cash through a business.

Cash flows can come from operating, investing or financing activities. 

  • The most common cash inflow is net income, but cash inflows also include any other source of cash coming into a business. 
  • Common cash outflows are wages, rent and loan repayments.

Understanding the Difference Between Profit and Cash Flow 

If you read the above and thought to yourself: ‘hey, isn’t that just profit?’

Close, but not quite. 

In fact, a few key small differences can make cash flow vastly different from net profit for a period. 

DYK?: 80% of all businesses fail over a 10 year horizon, and 80% of those businesses fail due to cash flow failures. Check out our guide on The 3 Levers of Cash Management.

What Separates Cash Flow and Profit 

Profit is a past measure of operations, that’s a fancy way of saying: 

  • It ignores the timing of inflows and outflows
  • It smooths amounts and includes estimates
  • It doesn’t consider balance sheet items
  • It doesn’t consider the future

Knowing the above we can start to imagine scenarios where a profitable business runs into trouble.

For Example:

Let’s imagine a business that makes a sale for $1,000 today on credit. Now so long as their costs aren’t higher than $1,000 their profits will increase. 

But, as they haven’t actually collected payment, there is no money in the bank. 

Despite profit increasing, until payment is received there is no increase to their cash inflow. 

If this business was only tracking profit, and not their cash flow as well, they may look at their financial statements, and incorrectly assume they have cash on hand for other activities like starting a new project, paying wages, or buying new equipment.  

Another thing to note about profit is that it doesn’t take into account estimates made for things like depreciation expenses (which are ultimately just estimates), and may not accurately represent expenses, or may ‘smooth them out’. 

The Importance of Cash Flow and Forecasting

A cash flow report is more than just a financial report. Cash flow is a key measure of financial health. After all, cash is the lifeblood of any business.

If there isn’t money in the bank you can’t make payments or sustain operations (even if the business is profitable overall as we saw above).

Cash flow forecasting allows you to track and predict future cash flow so you can plan for the future and make better informed business decisions. 

Check out our guide and FREE Cash Flow Forecasting TEMPLATE + Guide to start forecasting today.  

Interested in learning more about cash management and cash flow forecasting?

Check out these resources: 

Until next time!