Running a small business comes with its own set of financial challenges. Two terms that often cause confusion are ‘profit’ and ‘cash flow.’ Let’s break down these two financial concepts.
Profit, also known as net income, is what’s left after you subtract all your business expenses from your revenue. These expenses can include operational costs, taxes, and more.
For example, if you operate a subscription-based app with 200 subscribers each paying a monthly fee of $20, your revenue is $4,000. If your expenses like app maintenance, content creation, and marketing total $1,500, your profit would be $2,500 ($4,000 revenue – $1,500 expenses).
Cash flow, on the other hand, is the total amount of money being transferred into and out of your business. It’s a measure of your business’s financial health and indicates how well you can pay off your debts.
Cash flow can be positive or negative. Positive cash flow means your business’s liquid assets are increasing, allowing you to settle debts, reinvest in your business, pay expenses, and provide a buffer against future financial challenges. Negative cash flow means your liquid assets are decreasing.
Cash flow is determined by three main components: operations (cash generated from daily business operations), investing (cash used for investments in future growth or cash received from the sale of long-term assets), and financing (cash received from or paid to investors and creditors).
The main difference between profit and cash flow is their definition. Profit is the surplus after all expenses are deducted from revenue, while cash flow is the amount of money that is actually available to your business at any given time. This is what can be used for distributions to you as the owner.
A small business can be profitable but still have a negative cash flow. This can happen if the business’s current assets (cash, accounts receivable, and inventory) are less than its current liabilities (short-term debts and accounts payable). Conversely, a business can have positive cash flow but not be profitable.
Understanding the difference between profit and cash flow is vital for small business owners. Profit gives you an idea of your business’s overall earning potential, while cash flow shows you how much money is actually available to your business at any given time.
Remember, revenue is vanity, profit is sanity, but cash is queen. Understanding the difference between profit and cash flow is more than just financial literacy. It’s about gaining insights into your business’s financial health and making strategic decisions that drive growth and sustainability.
