Cash flow vs profit: key differences explained

It’s tempting to think cash flow and profit are the same. If you have plenty of cash flowing into your business, you must be making a profit, right?

Wrong. Cash flow and profit have some things in common, but their differences are important.  

What is cash flow?

Cash flow is how much cash a company has going out compared with how much it has coming in. A positive cash flow means your firm has more money coming in than going out. A negative cash flow is the opposite. 

In an ideal world, you’d always have a positive cash flow. But negative cash flow doesn’t mean your business is failing. In many cases, it just means you need to lean on business credit cards, loans and other business finance to help cover outgoings.  

Likewise, a positive cash flow doesn’t mean you’ve hit the jackpot and can float on the stock exchange. It may mean a few creditors have paid up, so there’s more money in your bank account to pay off loans and suppliers, or buy equipment. 

What are the different types of cash flow?

There are three categories of cash flow:

• Operating cash flow is money earmarked for production costs, and sales of goods or services 

• Financing cash flow covers money used to fund the company, including its capital, and outgoings, such as debt payments

• Investing cash flow comprises money flowing out to fund expansion projects, including research and development (R&D), that will ultimately benefit the company

As cash flow covers the movement of money into and out of a firm, certain finances aren’t included, because they are static. Examples include money that debtors owe you or savings in the bank. 

What is profit?

Profit is what you have left after subtracting your outgoings. 

There are three main ways to measure profit:

• Gross profit is what you have left after the cost of getting goods or services to market is subtracted from sales income. It may suggest you’re in the black, but it’s not always accurate. An apparent profit could disappear once you’ve included other costs

• Operating profit is what is left after deducting running costs such as rent, salaries and utility bills

• Net profit gives a precise picture of the money made after subtracting all outgoings, including taxes and interest payments

How are cash flow and profit different?

Cash flow and profit are the main ways to measure your company’s robustness. However, how they do this and what each illustrates is different.

Cash flow shows how a company operates based on what money is coming in, what money is going out, and how this cash is used. Profit shows the bottom line – whether the company can report revenue after deducting costs.

Profit shows the current level of a company’s financial success, while cash flow paints a detailed picture of its overall health. It takes account of R&D, loans, overdrafts, other debts and transactions that have a longer-term impact.

How do the differences between profit and cash flow affect business?

It’s possible to make a profit and yet have a negative cash flow. Or you could fall short of profitability, but have a positive cash flow. For example:

Profit, but negative cash flow

A plumbing firm wins a contract to supply and install fittings to all the bathrooms in a new block of flats. The costs of parts and labour are substantial, stripping the company of its cash flow, but the contract is lucrative. However, the client is delaying payment, so the company has negative cash flow. 

No profit, but positive cash flow

A sole trader sets up a taxi service. She buys her car through hire purchase and takes out a business loan to cover motor and business insurance. The loan also covers running costs, such as fuel, a work mobile phone and living costs. Although she quickly starts bringing in money, her loan commitments mean she doesn’t make a profit for the first two years.

Is profit more important than cash flow?

The ultimate aim of any company is to be profitable and use this revenue to grow. But success is built on the ups and downs of cash flow. Without cash flow, it’s difficult to invest for the future, pay salaries, utility bills and rent, and repay debts. This would render a business’s prospects gloomy and the chances of making a profit slim. 

Potential investors are always interested in cash flow, because it is a reliable indicator of how well your company manages its money. Profit is also important, but for a relatively young company, it’s further down the pecking order. You could win a one-off contract that inflates your revenue, for instance, but financial diligence over a long period is more likely to impress.

In contrast, you may make a profit, but if this money is only on paper, due to a slow-paying client, it’s not worth much. Likewise, if you plough all profits into an expansion plan, you could lack the funds to operate properly. This could have catastrophic results. 

In this case, cash flow is arguably more important than profit, especially in the first few years. But if a business fails to become profitable, cash flow gradually dries up. This would spell the end for the venture, lending weight to the argument that profit is more important than cash flow.