Cash Flow vs. Profit: Why Your Business Can Be Thriving and Still Broke

Running a business is hard work. Running it well enough to earn a profit is even harder. So, knowing that your business can be profitable and still somehow be broke might be discouraging. But if you understand how business finance works, you can putyour organization in a good position to succeed.

What’s the Difference Between Cash Flow and Profit?

Cash flow and profit are not the same thing. A business’s profit is how much money is left over after deducting expenses from revenue. An organization’s cash flow is the actual movement of money in and out of a business bank account. In fact, a profitable company can still fail if its cash is inaccessible.

Let’s get into these definitions in a little more detail.

What Is Cash Flow?

An organization’s cash flow is the net balance of cash moving in and out at a specific point in time. For most businesses, cash is constantly moving. When a business buys inventory, for example, money flows out toward its suppliers. When that business then sells inventory, cash flows in from its customers. 

And there are less obvious examples, such as utilities and taxes representing outflow, and customer payment installment plans representing inflow. Positive cash flow means an organization has more money moving in than out, and negative cash flow means the opposite.

What Is Profit?

Profit is the balance that remains when a business deducts all its expenses from its revenues. If revenue is greater than expenses, then a company turns a profit. If not, it’s “in the red,” meaning it owes more than it makes.

A business can distribute profits to its owners and shareholders, often as dividend payments. Or a company can reinvest profits back into itself, such as for research and development, or to expand its workforce or locations. 

How Can Profitable Businesses Be in Trouble?

The main point of a business is to earn a profit. So, if you achieve that, why might you still be in poor financial health?

The answer is if there’s a gap between the profit you make and your cash flow. This can manifest in several ways, including:

• Tied-up inventory: An organization can show a massive profit because it sold a lot of goods. However, if most of its cash is tied up in unsold inventory or raw materials, then it still can’t pay expenses.
• Bad timing: Accrual accounting can reveal business flaws. An organization may record a sale when it closes a deal, but might have to wait 30 days or more to actually get paid. In the meantime, the business still must pay expenses. Without the cash on hand, it’ll have to borrow, eating into its revenue.
  
• Debt: Most companies don’t count principal loan repayments as business expenses on an income statement, only the interest on that debt. Therefore, a highly profitable business could owe large debt payments that entirely wipe out its actual cash reserves.

Managing Your Business Cash Flow

All businesses have expenses, and many take out loans; it’s perfectly healthy business behavior. But it requires planning to get it right. Contact a Vectra Bank professional today to discuss your business banking options.