If you’re running a business, then you need to know the difference between profit and business cashflow. Without a clear understanding of these two terms, it will be incredibly difficult to determine whether your business is operating efficiently.
Of course, everyone starts a business with the goal of making profits. However, they eventually learn that cashflow is equally important. Also, it’s important to note that your business can turn a profit even though your cashflow is negative.
Understanding Business Profit
Profit is one of the most important factors used to measure the success of a business. In short, profit refers to the money you end up with once you deduct the expenses needed to generate revenue.
For instance, if your annual revenue is $1 million but you spent $800,000 to generate that revenue, then your annual profit is $200,000. There are two main types of profit – gross profit and net profit.
Gross profit refers to the revenue generated from the sales of products minus the cost of that inventory. For example, if you’ve generated a monthly revenue of $10,000 but the stock cost $6000, then the gross profit is $4,000.
Net profit on the other hand, factors in operating and other expenses. Some of the operating expenses that you might factor in include rent, office expenses and salaries for your employees, among others. Therefore, net profit is a better reflection of your company’s overall profitability.
Even though you’re running a business to make profit, cashflow on the other hand, presents you with a better metric for assessing your company’s short-term and long-term goals.
In simple terms, cash flow refers to the amount of money moving into and out of your company at any given time. Cash flow is usually assessed over a certain time frame.
The time frame can be weekly, monthly or quarterly. If your business is cash flow positive, then it shows that the amount of money flowing into your business is more than that which is flowing out within a particular period.
And, if you have a negative cash flow, then it’s an indication that there is more money flowing out of your business than is coming in.
Now that you understand what both terms mean, it’s important to understand their key differences. You also need to know how these apply to your business. For instance, your business can have a positive cash flow but no profit.
In this situation, money is coming from other sources into your business other than revenue from product sales. That money might be coming from your own pocket. Or, you might take out a loan to prop up the business.
Such a transaction is a liability on the balance sheet. On the other hand, a business can have a large profit with a negative cash flow.
In this situation, the business owner might have taken the company’s money to service personal expenses or to purchase a large amount of stock. Therefore, the main difference between profit and cash flow boils down to the source of the transactions.