What’s the difference between cash flow and profit? The two are often confused and yet they are both very important aspects of running a business.
What is cash flow?
The dictionary definition of cash flow is “the total amount of money being transferred into and out of a business, especially as affecting liquidity.”
A steady and recurring cash flow is vital for businesses because it helps cover regular operational costs and expenses, including employees’ salaries and taxes. A positive cash flow also allows reinvesting in the company, facilitates the settling of any debts and increases a company’s liquid assets.
Cash flow can also be used as a helpful financial metric to:
- Define a project’s rate of return or value
- Determine problems with a business’ liquidity
- Evaluate the quality of a business’ income
- Evaluate the risks within a financial product.
What is profit?
The dictionary definition of profit is “a financial gain, especially the difference between the amount earned and the amount spent in buying, operating, or producing something.”
Profit is the money a business makes after all expenses. There are three types of profit: gross profit, operating profit and net profit. A brief explanation of all three types is outlined below.
Gross profit: This equates to sales minus the cost of goods sold. Gross profit looks at profitability after direct expenses.
Operating profit: This is calculated by subtracting operating expenses from gross profit. Operating profit looks at profitability after operating expenses.
Net profit: This is any leftover income after all expenses have been paid – including taxes and interest.
Why is cash flow so important?
Cash flow is important because a business can be profitable and still not have adequate recurring income. For instance, a company can be selling a product at a profit. However, that product may require a long sales chain and customers may not pay their invoices on time. These late payments create a problem because the business has suppliers waiting for payment for the materials or service that created the product the company is selling. In turn, this may affect payroll and further operational expenses. In a worst-case scenario, a cash flow crisis may lead to bankruptcy.
Is there a solution?
If you are running a business that collects recurring payments from clients and customers, then you may require a Direct Debit solution.