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Cash flow is the money that flows in and out of your business throughout a given period, while profit is whatever remains from your revenue after costs are deducted. In this sense, the key difference between the two metrics is time. Even if you have a successful product with rising sales, you could end up facing cash flow issues, and despite reaching profitability, your business may be unable to meet its financial obligations.
Ultimately, cash flow and net profit measure different things. While profit is the goal — and an indicator of financial health — cash flow is the lifeblood of an organisation, keeping operations ticking over on a day-to-day basis.
For a growing business, both cash flow and net profit are important, but in the short-term, cash flow is probably the number one concern. While it seems counterintuitive, it is possible for the growth of your business to generate issues with cash flow. For example, during a period of high growth, a company may accept too many orders without having enough cash to produce them, making it necessary to sell stock or seek a loan. Find out more about how GoCardless helps businesses collect payments automatically.
GoCardless is used by over 60, businesses around the world. Cash flow represents the cash inflows and outflows from the business. When cash outflows are subtracted from cash inflows the result is net cash flow. Profitability represents the income and expenses of the business.
When expenses are subtracted from income the result is profit loss. You may think of cash flow as transactions that affect your business "checkbook" and profitability as items that impact your "income tax return". Cash inflows and outflows show liquidity while income and expenses show profitability. Liquidity is a short-term phenomenon: Can I pay my bills? Profitability is a medium-term phenomenon: Am I making money?
The situation where profit and cash flow are at odds is very common for a small business which must invest in assets in order to grow. The reasons can always be seen on the balance sheet.
To understand where your cash has gone, you must first understand the relationship between profit and cash flow, and how each is calculated. Profit is shown on an income statement and equals revenues minus the expenses associated with earning that income. This measures the ongoing sustainability of the company. Cash Flow Cash flow measures the ability of the company to pay its bills. The cash balance is the cash received minus the cash paid out during the time period.
When cash on hand is negative, the company has spent more cash than it has brought in during that time period. The positive profits and not so positive cash flow riddle is essentially an accounting issue.
Accountants generally prepare financial statements using accrual basis accounting. With this method, expenses are reported only when goods or services are completely consumed, regardless of when the bill got paid.
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