Making profits but cannot see it in the bank account? Clients often ask why I am making $50k in profit but only see $20k in the bank. Where did the other $30k go?
To answer this question, it is important to know the difference between cash flow and profit.
What is cash flow and what is profit?
In a nutshell, cash flow refers to the money flowing in and out of your business during a set period. It includes only cash-based activities such as cash sales, collection from customers, bills paid, etc.… It does not include sales made on credit or money owed to your debtors. Cash flow is normally used as an indicator by lenders and investors to assess the well-being of your business.
Profit, on the other hand, is the remaining balance from sales revenue after deducting all costs. It includes sales made on credit and expenses incurred even if not paid yet.
So, is Cash flow the same as Profit? What is the difference?
Cash flow and profit are not the same. Cash flow only considers cash-based transactions. Therefore, certain items go into the profit calculation such as credit sales that are not reflected in the cash flow. In this sense, both measures are incredibly important to track and cannot mix them.
Profit will show you the immediate success of your business. However, cash flow will show the financial outlook of your business over time and its viability to meet current and unforeseen obligations.
Consider the following scenario:
You look at your income statement and you see that you made $50 K in profit in 2020. You decide that you can utilize part of the profit to expand and offer a new product. This decision based on profit only will not yield favorable results. You need to take the current cash flow into consideration. Offering new products often involves additional costs that must be paid immediately. Do you currently have a positive cash flow that allows you to do so? If not, then expanding is not the smart decision to make now.
Which is more important, cash flow or profit?
Both cash flow and profit measure different things. While profit is the indicator of business success, cash flow is the lifeblood of any business. Therefore, both are important in the long term. In the short term, however, cash flow is probably the number one concern.
If you need assistance getting your cash flow under control, contact us to schedule a free 30-minute consultation session where we go over your needs and how can we help you address them.
