What is the difference between profit and cashflow? Why are they both so important?

Thursday 3rd November 2022

What is the difference between profit and cashflow? Why are they both so important?

Thursday 3rd November 2022
Written by Steve Roxby

There is a common misconception that cashflow and profit are the same thing. Whilst this is not the case, one cannot exist without the other, and it’s important to understand what they are respectively, and how they sit into the overall financial plan of your business. In knowing this, you will be much more prepared to be a sustainably operated business, especially in the event of unexpected financial hurdles.

So what is profit?

In short, profit is income less expenses, and is normally accounted for when the income is earned, or invoiced, and the expenses are incurred.

The difference between income and expenses may be negative and classed as a loss, or positive and termed as profit.

What is cashflow, and how is it different to profit?

Cashflow refers to when the income is received, or the expenses are paid. This difference is referred to as cashflow. If the difference is negative it is regarded as cash deficiency whilst a positive result is cash surplus.

If we consider the effect of income on profit and cashflow, income is recorded at the time of invoice, thus contributing to profit. That income however will not be received until the customer pays the invoice. While it is common for many retailers to receive the payment at the time of sale, for many businesses the payment will not be regarded as cashflow until it is received.

Also, there are cashflow movements that do not get recorded as income or expenses and thus do not impact profit. For example, loan repayments are not an expense of the business and therefore do not reduce profit, but they are a cash outflow; and thus affect the cashflow position.

Why do we need to plan for cashflow

Quite simply, if a business does not have cashflow it will not be able to pay expenses to operate the business. For example, if wages can not be paid, then staff will leave. If you can not buy product, you may have nothing to sell, etc.

As mentioned earlier, the business may have other cash outlays and thus the planning to confirm funds will be available to meet these as they fall due, is vitally important.  Examples of other cash outlays is loan repayments, income tax obligations, and funds for business expansion.

How do cashflow and profit work together?

Without profit, you don’t have a viable business and you will eventually liquidate. Your profit also generates cashflow, which you need to run a business. Profit is needed for cashflow to exist, and cashflow is needed for profits to continue (as it sustains the ability to pay for the goods and services required to keep your business running in the first place). How you classify your funds, into profit and cashflow, is purely timing. You use part of your profit to inject into your cashflow account.

If you want your business to grow, you must have cashflow.  It is what allows you to choose the future direction of your business, and to sustainably expand it.

We highly recommend business owners not only prepare profitability projections but most importantly cashflow forecasts. This will identify any cash surplus or deficiency so that strategic planning and/or corrective actions can be made in advance.

If you need to monitor and manage your profit and cashflow in a more effective and lucrative way, Maxim can assist you with solid pathways to keep you on track today, and allow for healthy future growth.