No matter what business you are operating, many business owners especially those who are running e-commerce often focus on profits but ignore the importance of cash flow. Many people use the terms “cash flow” and “profits” interchangeably, but they are not the same. As an entrepreneur, it’s crucial that you differentiate between the two if you want your business to run smoothly.
Getting down to the definition, cash flow is the movement of money in and out of your business, which will be reflected in your financial statements. On the other hand, profit is the financial benefit when a company earns more revenue from its activities than the costs of running those activities, it makes a profit.
Profits are essential to any business, but what really matters is a business’s cash flow. Even if your business is meeting all of its financial obligations, it may not be profitable as it doesn’t have positive cash flow. Being mindful of your company’s cash flow is critical to its success. In this article, we will clearly explain the differences between cash flow and profit.
What you’ll learn
What is Cash Flow?
Cash flow is the net amount of money that moves into your business’ finances at any specific time. Steady cash flow is a fundamental part of keeping your business afloat, it can mean the success or failure of your company. Negative cash flow is when more money is flowing out of a company than what is coming in. Positive cash flow is when there’s more money coming in than going out.
Types of Cash Flow
1. Operating Cash Flow
It is used to describe net cash generated from your business operations. Staying positive with operating cash flow is key to sustaining business growth and expansion.
2. Investing Cash Flow
It is the cash that your business generates from investment-related activities. This could apply to anything from the sale of property or assets to securities and equipment. If you’re regularly investing in your business, as many good companies do, your cash flow for investments is likely often negative.
3. Financing Cash Flow
It is the net cash generated by your business and used to finance the company’s operations between creditors, shareholders, or investors. There are several different types of financing cash flow, including equity, dividend payments, and debt.
Why do you need a Cash Flow Statement?
The cash flow statement is a critical financial document for any business owner. It is a document that businesses use to track and report their incoming and outgoing money over set periods of time, such as a fiscal year. This in-depth financial analysis is an accurate portrayal of cash inflow and outflow, as well as the final reconciled balances.
What is Profit?
The revenue left over after you’ve paid operating expenses is known as “profit”. The leftover money is usually given to shareholders as dividends or reinvested into the company to help it grow. Reinvesting profit can come in many forms, such as purchasing new inventory, allocating a budget to research and development, or selling products and services.
Types of Profits
1. Gross Profit
It is revenue minus the cost of goods sold (COGs). It’s crucial to remember that this number does not include any fixed costs, though it will be impacted by labor and material expenses. Most businesses experience fluctuating gross profit margins.
2. Operating Profit
It is the net profit earned from a company’s core business operations. This figure does not include taxes, interest payments, and cash flow from revenue sources outside of your main business. Operating profit is also known as EBIT, or earnings before interest and tax.
3. Net Profit
Cash Flow VS Profit: What is More Important to a Business?
The answer to this question depends on the specific details of your business. Even if you are making a profit each month, you may not have enough liquid cash to pay your employees if that money is tied up in accounts receivable or other physical assets. You won’t see any positive cash flow until you either pay off your business debts or greatly increase your revenue. In this case, cash flow is more important than profit as it’s necessary for the sustainable running of your business.
Without profit, your business’s cash flow will suffer and eventually decline. When it comes to your business, profit is more important. It can be difficult to decide whether you should focus on cash flow or profit, but remember that you can always purchase cash flow if necessary. You can use your personal assets as capital or apply for a small business bank loan to get through tough times.
Does Rapid Growth Cause Cash Flow Issues?
Although growth is good, it can sometimes inhibit a business’s ability to generate or maintain cash flow. As a business owner, it’s crucial that you take the time to understand these terms and how they can impact your company in the long run. If your business grows faster than expected and you take on too many orders without having the money to produce them all, you could get into some trouble. You could get your business back on track with a loan or the sale of stock, but it’s always better to avoid that situation altogether by being proactive.
Cash flow in your business is crucial for its success. FastLane is here to help you collect daily data from different online sales platforms and convert it into your accounting books. If you’re feeling burdened by accounting and administrative work, contact us! We also provide other corporate services like audit services, company secretarial services, and company formation services in Hong Kong. To learn more, please contact us.