Cash flow versus profit: what every small business owner needs to know
Profit and cash flow are not the same thing and confusing the two is one of the most dangerous financial mistakes a small business owner can make. Here is what you need to know.
Author
Marcus Reid
Read time
4 min read
Published date
Category
Finance
You can be profitable and still run out of money
This surprises many business owners but it is entirely possible to show a profit on paper while simultaneously struggling to pay your bills. Understanding the difference between cash flow and profit is one of the most important financial lessons you can learn as a business owner.
What is profit
Profit is the difference between your revenue and your expenses over a given period. If you earned more than you spent, you made a profit. Your profit and loss statement shows you this number.
But profit is an accounting concept. It does not necessarily reflect the actual cash available in your bank account at any given moment.
What is cash flow
Cash flow refers to the actual movement of money into and out of your business. Positive cash flow means more money is coming in than going out. Negative cash flow means the opposite and it can create serious problems even for profitable businesses.
The timing of cash flow is everything. If you invoice a client for a large project in December but do not get paid until February, your December books might show strong revenue while your January bank account is nearly empty.
Why businesses fail despite being profitable
Cash flow problems are one of the most common reasons small businesses fail. A business might have plenty of future income on paper in the form of unpaid invoices or signed contracts but if the cash is not in the bank when bills are due, operations grind to a halt.
This is especially common in service businesses with long payment terms, seasonal businesses with uneven revenue cycles, and fast growing businesses that spend heavily to fulfill new contracts before getting paid.
How to manage both effectively
The key is to track both metrics regularly and understand what each one is telling you. Your P&L tells you if your business model is working. Your cash flow statement tells you if your business can survive right now.
Vooks provides both reports every month so you always have the complete financial picture you need to run your business with confidence.
