Cash flow and profit: these are two terms that seem to be used interchangeably, in spite of how vastly different their definitions are. However, it is imperative that such a mistake is not made in the business world – especially in the case of a startup or a small business that is striving to expand – as it can have negative impacts on how a business is actually run.
To clarify, here are several ways in which cash flow and profit differ:
Firstly, cash flow is defined as “the money that is moving (flowing) in and out of your business in a month.” Money flows into a business when customers or clients purchase your products or services. Meanwhile, money flows out of your business when you pay expenses such as rent or mortgage, monthly loan payments, taxes, and so on.
Profit, on the other hand, is defined as “the money a business makes after accounting for all expenses.” This is the money a business is left with after making loan, rent, mortgage, or other payments.
Seeing as these terms are not synonymous, it is possible for a business to make an excellent profit but have little cash flow. This is typically seen in small businesses that are just getting off the ground, during which time a temporary line of credit is likely used to maintain a positive cash flow.
However, such a trend is detrimental to an established business, as an inadequate cash flow means they cannot pay suppliers of materials, rent or mortgage, or other vital expenses. This is why some successful and profitable businesses have been driven into bankruptcy, even during a time of growth.
It is important to note that growth is not inherently good for a company. Unfortunately, if a company sees a sudden spike in popularity and an increase of new orders, their expenses could skyrocket past the breakeven point and diminish their remaining profit.
If a business is diligent and remains up-to-date on all of their relevant cost data, they may be able to counteract these effects and reestablish their profitability. However, this occurs very rarely, hence why so many small businesses – and even some larger corporations – must close their doors for good.
The best way to combat these major fluctuations is to be mindful of your expenses, keep track of cash flow and profit, and review the possibility of curbing growth in order to work toward long-term success.