Cash flow and profit are two different financial parameters, both of which are important for running a successful business.
Cash flow is how much money is going into and out of your business at a given time: the payments you are receiving and the payments you are making. Cash flow impacts how much money you actually have available at any given time.
Profit is how much financial gain your company is making on its products or services. If you are bringing in more money than it costs to run your business, you are making a profit.
Cash flow and profit are both important measures of success for a business and can affect how stable your company is. They also intersect with other important corporate issues, especially when your company grows rapidly.
What Is Cash Flow and Why Is It Important?
Cash flow is the money that flows in and out of the firm from operations, financing, and investing activities. It's the money you have available to meet current and near-term obligations.
Cash flow is what allows you to pay your expenses on time, including suppliers, employees, rent, insurance, and other operational costs.
Insufficient cash flow means that a business cannot meet its financial obligations, such as paying suppliers or even employees. This can happen even if you are making a profit on your products and services. In a growing business, a suddenly successful product can often create a cash flow crisis.
What Is Profit and Why Is It Important?
Profit, also called net income, is what remains from sales revenue after all the firm's expenses are subtracted. A business cannot survive unless it is profitable.
Profit means your business is making more money than it spends to stay in business.
Sometimes, as with cash flow, the success of a product can raise expenses, which can impact your profit. Lowering expenses may allow you to make a profit, but this requires making effective cuts that don't compromise your ability to stay in business.
How Cash Flow and Profit Interact
Being profitable does not mean you automatically have adequate cash flow.
For example, if your product goes through a long sales chain and some of your wholesale customers don't pay on invoices for 120 days, you can make a profit on those products but still not have the cash available. If the suppliers of the material you need to make those products expect to be paid every 15 or 30 days, you won't have the cash you need to pay them and continue making products.
Even though your unit sales are increasing and profitable, you won't get paid in time to pay your suppliers, meet payroll, and pay other operational expenses. If you're unable to meet your financial obligations in a timely way, your creditors may force you into bankruptcy at a period when sales are growing rapidly.
- Cash flow is the actual money going in and out of your business.
- Profit is your net income after expenses are subtracted from sales.
- A business can be profitable and still not have adequate cash flow.
- A business can have good cash flow and still not make a profit.
- In the short term, many businesses struggle with either cash flow or profit.
- Rapid or unexpected growth can cause a crisis of cash flow and/or profit.
- Both cash flow and profit are necessary to stay in business over the long term.
Likewise, growing and having steady cash flow does not mean you are making a profit.
For example, if you are worried about paying suppliers or purchasing new equipment, you might borrow money in order to meet expenses. This creates sufficient cash flow for your business. But if the debt that comes with paying that loan back raises your costs above the breakeven point, you are no longer making a profit.
Rapid or unexpected growth can cause a crisis in either profit or cash flow. Many businesses, especially new ventures, struggle with either cash flow or profit at some point. However, if either cash flow or profit remains insufficient, eventually, your business will be unable to continue operating.
How Rapid Growth Can Cause Business Failure
Rapid growth can cause a business to struggle with either cash flow or profit, and sometimes both. it can also create other struggles that impact both cash flow and profit.
- Operations: If the volume of product you are creating increases, that can change your operational requirements. This can increase your costs, which lowers your profits. If the changes aren't made in time, it can impact your supply, which decreases your cash flow.
- Customer service: New products spur sales but may lead to expensive warranty repairs or even product recalls. This reduces your cash flow. A customer service staff may not expand in concert with sales growth, which also leads to customer dissatisfaction. This can decrease your sales and corresponding profits.
- Overspending: A rapidly successful product may lead your company to make overly-optimistic spending decisions, such as expensive equipment purchases and imprudent facilities improvements. This can reduce your profit margin and tie up cash flow that is needed for other expenses. If these expansion projects are financed with debt, then you can decrease both your profit and cash flow, causing your company to lose its competitive edge in the market.
In a growing company, keeping track of cash flow and profit also requires attending to these related issues. In some cases, it may be necessary to curtail growth or delay expanding in order to assure your business's financial stability and long-term success.