You might think if you have good cash flow, you’re making good profit and vice versa, but that is easily not the case.
Cash flow and profit are really different concepts and if you understand them, you can maximise both and run a healthy business.
(Read our 5 top tips for improving your cash flow here.)
Cash flow is the money going in and out of your business over time. Profit is the money you make when you take your outgoings away from the money you have coming in.
It’s therefore entirely possible to have high sales and cash flow into and out of your account, but low profit if you also have high costs.
Similarly, you could have a profitable business but if you have problems with getting payments in to pay your own suppliers, your cash flow may be poor.
Both concepts are important but they measure different things.
Net vs gross profit
Profit itself can be divided into two measures too.
Your gross profit is the income from sales minus the costs directly associated with those sales.
Your net profit is your income minus all the costs associated with running your business– your ‘bottom line’ in effect.
Again – both measures are important but different. Knowing your gross profit can help you develop your pricing strategy, and knowing your net profit can help you understand if your overhead costs are justifiable.
Which is more important – cash flow or profit?
Obviously making a profit is your key business goal. But if you are starting out and your business plan doesn’t indicate profit will be made for a little while, or you are launching a new product, a lack of profit will be expected.
Cash flow is often used as an indicator of the health of your business by banks when considering lending requests, and by investors. Poor cash flow can mean not being able to pay your bills and could risk your whole operation.
A great example is if you have taken on vastly more orders than usual. It may be profitable in theory but if you don’t have the cash flow to fulfil the order, you could fall into difficulties.
Remember ‘profit is sanity but cash flow is reality’!
(If your business is struggling at the moment, read our article on managing cash flow in the current climate here.)