Profit and Cash Flow; What are the differences?

Most business owners don’t understand the difference between PROFIT and CASH FLOW.

Not knowing this difference, could leave your business without cash and push you into bankruptcy.

Here are the key differences between PROFIT and CASH FLOW

1. The Basics

PROFIT: Shown on the Profit & Loss (P&L) statement. Starts with revenue, deducts expenses, to arrive at Profit.

CASH FLOW: Starts with profit and makes adjustments for items that profit fails to take into account.

2. Flaws with PROFIT

PROFIT has flaws because accounting rules dictate the way something should be recorded.

For example: if you buy a piece of equipment, accounting rules require you to expense the item in increments (i.e. via depreciation).

3. Why does Cash Flow Matter?

Cash flow matters because it’s the lifeblood of a company. You can’t pay for expenses with accounting profits, you need cash flow.

You can’t buy a new piece of equipment with accounting profits, you need cash flow.

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4. Cash Flow From Operations

To tell how much CASH a business has made, you have to look at the “Cash Flow From Operations” section of a company's financial statements.

CASH here is actual MONEY the business made vs. Profit which isn’t money but an accounting measure.

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Differences between CASH FLOW and PROFIT

There are a few critical adjustments that are made to profit when calculating cash flow

Here are those items:

1. Depreciation

Profit: Recognizes machinery and equipment expenses in increments over a number of years does NOT match cash outflows.

Cash Flow: Recognizes machinery and equipment purchased fully in the year it is purchased (under “investing activities").

2. Inventory

Profit: Inventory that is sold is expensed. Inventory purchased that is to be sold in the future is not taken into account does NOT match cash outflows.

Cash Flow: Inventory sold is taken into account and inventory purchased is recorded as a cash outflow.

3. Accounts Receivable

Profit: Sales that are sold on credit are recorded as revenue but the cash hasn’t been collected does NOT match cash inflows.

Cash Flow: Sales sold on credit are removed. Only cash actually collected from customers is taken into account.

4. Deferred Revenue

Profit: Cash received for future product delivery is not recorded as revenue, it's recorded on the balance sheet does not match cash inflows.

Cash Flow: Cash received for future product delivery is included in cash flow when it’s received.

Other Cash Flow Items

If you look at a company’s cash flow statement, you will notice that there are 2 other sections:

• Investing Activities: Cash used by the company to invest in assets or M&A.

• Financing Activities: Cash received or paid to the company’s investors or banks.

Is profit useless?

No! Profit is the first thing you need to calculate cash flow. However, cash flow takes PROFIT further by adjusting for items that make a real impact to money actually coming IN or going OUT of a business

That's why CASH FLOW is the LIFEBLOOD of a business.

Hope you learned something about the difference between PROFIT vs. CASH FLOW.