Even if your small business is profitable, you can risk running into cash flow problems. How? 

If you don’t have enough liquid cash (cash flow) on hand to pay your expenses on time, your business can fall behind on payments. And that can mean higher interest rates or late fees, while slow payments can hurt your business credit scores.

Many business owners don’t truly understand what cash flow is when compared to profit, but the difference is essential. 

Miranda Marquit, a freelance writer for more than two decades, learned the difference the hard way. 

“In the early days of my business, I emphasized profit and was surprised when I still ran out of money or fell behind,” she says. “I expected profit at the end of the month, but in the meantime, I was overdrawing my account while I waited for clients to pay because of when the bills were coming out. So, by the time the next round of payments came in, I’d have to play catch up, and then there would be more problems going forward.”

She learned how to turn things around, and here we’ll offer strategies that you can use to do the same.

Cash Flow vs Profit

Cash flow refers to the money that flows in and out of your business. Income and expenses. What you’re bringing in and spending.

Profit, however, is the money you have after deducting your business expenses from overall revenue. Both are important, but cash flow is essential to keep your business running in the here and now.

“Cash flow is often celebrated because it’s the bigger number ,” says Jim Wang, founder of the personal finance blog WalletHacks, “but profit is what matters because that’s how much you can put in your pocket. Having a $10 million dollar business sounds sexier but if profit margins are small, it’s less attractive than one with a lower top line number but higher profits.”

Let’s dive deeper into each of these so you have a better understanding of the role that cash flow and profit hold in your business.

What Is Cash Flow?

Cash flow is essentially the cycle of funds going in and out of your business bank account from operations, investing, and financing activities. It’s the amount of cash that you have at your disposal at any given time. Your business can either be cash flow positive or cash flow negative.  

Positive cash flow occurs when the ratio of cash inflows is greater than your cash outflows, or when there is more cash coming into your account than you are spending. 

Negative cash flow happens when your cash outflows are greater than your cash inflows. You are spending more than you are bringing in.

Examples of cash inflows are:

• Money coming in from accounts receivable
• The sales of services and products
• Borrowed capital like lines of credit or small business loans 

You’d see these on your income statement.

Cash outflows are any debts, liabilities, or operating costs that running your business may incur. Examples of cash outflows (also known as cash outlay) are:

• Money going out for accounts payable
• Payroll, taxes
• Inventory
• Rent
• Loan payments
• Other business expenses

If you decided to borrow $75,000 in equipment financing, the lump sum of capital you would receive upfront would be considered part of your cash inflows, and your payments on the loan would be considered among your cash outflows.

What is Profit?

Profit (also known as “net profit” or “net income”) is the amount of money that remains after all expenses — including cost of goods sold (COGS), as well as operating costs, interest payments, loan payments, and taxes — are deducted from your revenue. 

To figure out your total profitability, you need to understand both gross profit and net profit.

Gross profit is the difference between your income and the total cost of goods sold. For example, let’s say you own a flower shop. You bring in $25,000 in revenue in April, but your cost of goods sold (i.e. wholesale flowers) amounts to $10,000. Your gross profit would be $15,000. 

Revenue – Cost of Goods Sold (COGS) = Gross Profit 

$25,000 – $10,000 = $15,000

Another number here that can be helpful is your gross profit margin. If you take your gross profit ($15,000) and divide it by your revenue ($25,000), you arrive at .6, or 60% profit margin. That’s pretty great! This tells you how well your business is doing financially.

Your gross profit is what you make from selling your inventory of flowers, but it does not account for all the other operating expenses that are involved in running your flower shop. For example, the cost of rent, electricity, payroll, and advertising are all expenses that you need to pay for with your gross profit. Factoring in your operating expenses, which we’ll say were $5,000, your net profit for April would be $10,000. 

Gross Profit – Operating Expenses = Net Profit (or Net Income) 

$15,000 – $5,000 = $10,000

When it comes to financial statements, you’d identify your gross and net profit on the profit and loss statement.

While profitability provides you with a snapshot of your financial situation during a specific period of time in your accounting, it fails to account for the day-to-day stability of your operation. That’s where net cash flow comes in.

What’s the Difference Cash Flow and Profit?

While being cash flow positive and profitable may seem pretty much the same at first glance, there’s a key difference that is important to understand.

“Before starting my own business, I didn’t realize that cash flow and profit were separate things that needed to be managed distinctly,” says R.J. Weiss CFP®, CEO of The Ways To Wealth, a personal finance education company. 

“It’s easy to assume that as long as you’re profitable, your cash flow will naturally be strong, but that’s not always the case. Profit might look good on paper, but if your cash isn’t coming in when you need it, it’s a struggle.”

To function, you need operating cash flow to meet payroll, make rent and insurance payments, and handle the laundry list of other day-to-day expenses to keep business running as usual. 

Many businesses use the accrual method of accounting, which records income and expenses when you earn or incur them — regardless of whether the cash has actually been exchanged. 

If you’re sending out invoices to clients that may not pay those invoices for 30, 60, 90, or even 120 days, your real-time cash flow situation will look very different than your profitability — and you may find yourself without enough liquidity to keep your company running. 

Let’s use a single invoice to illustrate this point. You land a huge opportunity with a wedding planner, who needs $15,000 worth of arrangements for an upcoming wedding. You invoice the customer on May 1 with a deadline of 60 days. You also have to pay your vendor $8,000 for the inventory (flowers) within the next 30 days.

Without factoring in your operating expenses for this transaction, your profit for May would be $7,000 — not bad at all!

But, this fails to give you a clear picture of your cash flow because you might not get paid that $15,000 until after your $8,000 invoice for the flowers is due. That’s where the cash basis of accounting comes in. While used less commonly, it is important for gauging how much cash you actually have on hand, as revenue and expenses aren’t actually recorded until the money is exchanged. With terms of net-60, you wouldn’t actually receive the money until July 1. See below: 

	May 1	June 1	July 1
Inflow	$0	$0	$15,000
Outflow	$0	$8,000	$0
Net Cash	$0	-$8,000	$7,000

Which One is More Important to a Business: Cash Flow and Profit?

The truth is: both cash flow and profit are important. It’s not an apples-to-apples comparison. While profitability is more important over time, cash flow and the availability of working capital are going to affect your daily operations and short-term finances.

There are profitable businesses that go under every year because they have poor cash flow. If you don’t have cash on hand to cover your expenses, being profitable in the bigger picture isn’t going to do you much good.

“Both are important,” Wang explains, “especially if you want to eventually sell your business, because there are things you can do to lower profits for tax purposes. You can sometimes have high cash flow and low profits this year but then adjust the business to be more profitable, which is attractive to buyers.” Wang, who has sold a previous business, notes that “some companies and investors are not interested in low cash flow, high profit business. Others are only interested in those.”

What Can Lead to Cash Flow Problems

In business, timing can be everything. 

“Getting my cash flow on track was a big deal for me,” Marquit explains. “For a while, I was constantly wondering how I (could) be behind when everything showed that I made enough money to cover the bills. But the timing turned out to be so important. 

“If my web hosting bill came out of my account and then payroll was run two days before client funds were deposited, then I might overdraft. Payroll would go through, but there would be a negative balance, and then, when the client funds arrived, I’d have to make up the negative balance (including the fee).” 

She found that tracking when money came in, and when bills needed to be paid, made all the difference. 

Cash flow problems arise when your cash inflows and outflows aren’t aligned; resulting in too much money being spent before enough money comes in. Factors that can cause these types of cash flow problems include: 

• Excessive inventory
• Late customer payments
• Unfavorable payment terms (both the ones you give and receive)
• Not having or sticking to a budget
• Too much debt
• Unexpected or rapid business growth
• Seasonal fluctuations in sales
• High fixed costs
• Overreliance on a single customer or product
• Inefficient billing and collection processes

And the big one that trips up many business owners: taxes. 

“I underestimated my taxes one year,” says Weiss, “so I had to use the excess Q1 profits to pay a tax bill from years past, along with estimated taxes for the quarter itself.” 

Remember to set aside money for taxes, including estimated quarterly tax payments. If you don’t know how much to save, talk with your accounting professional.

Forecasting Cash Flow

Cash flow forecasting can help you better understand the ebbs and flows of money in and out of your bank account and can help you make smart financial decisions to ensure you don’t suffer a cash crunch. 

“My business earns the biggest percentage of its revenue each year in (the first quarter of the year),” Weiss notes. “This means that the income I generate in those first few months has to sustain the company and myself for the rest of the year. While the business shows a paper profit, managing cash flow for the rest of the year to gear up for Q1, the following year becomes a game of chess.”

Another example: you might learn that while you offer net-60 terms to clients, most of your vendors offer only net-30, which means you won’t always have funds to pay your invoices. You have a few options here: you could pull back to net-30 terms for your clients in an effort to align positive and negative cash flow, or you could explore business financing options that would put money in your account so you can cover your expenses on time.

You could, for example, take out a line of credit that lets you access cash when you need to pay expenses but don’t have the money to cover them. Then, when your clients do pay you, you can pay back what you’ve borrowed.

How to Manage Cash Flow for Better Net Profit

Your net profit is tied to many aspects of your business, and cash flow plays a significant role. The very first step is to make sure you are keeping up with your bookkeeping and tracking the movement of cash in your business. 

Once you have that baseline, here are some steps to manage your cash flow better and increase profits:

1. Negotiate better terms with suppliers. Ask for longer payment periods or discounts for early payments.
2. Shorten your invoice terms or request payment at the time of service. This speeds up cash inflow.
3. Review inventory and product offerings regularly. Eliminate slow-moving items and focus on high-margin products.
4. Consider leasing equipment rather than buying. This preserves cash for other business needs.
5. Review your pricing strategy.
6. Implement a solid accounts receivable system. Follow up on late payments promptly.
7. Offer discounts for early payments to encourage customers to pay faster.
8. Use technology to streamline operations and reduce costs.

What works for one business might not work for another. Analyze your specific situation and choose the strategies that align with your goals and resources.

Nav’s Final Word: Cash Flow vs. Profit

While we went through a simplified example with a single invoice, if you’re sending out multiple invoices with different payment terms while managing the day-to-day operational expenses, you may see how staying out of the red could get tricky. 

That’s why it’s so crucial for small business owners to not only understand the difference between cash flow vs. profit, but also figure out better ways to increase cash flow. Cash flow management can help your company better predict when you’ll have money in the bank and strategize to ensure you don’t have to make financial decisions out of desperation. A profitable business is one who not only realizes an overall profit that also has enough cash to pay bills on time.

“Thinking only in terms of profit led me to neglect the timing of how my money was moving through my business,” says Marquit. “Once I began tweaking when I paid my bills, added a small business credit card to the mix, and built up a reserve, things got a lot easier.”

Like Marquit, many business owners find it helpful to use a business line of credit and/or business credit card to help smooth out cash flow. 

Nav can help. Nav is a financial health platform specifically built for small business owners to track and improve business credit and cash flow health, alongside a marketplace of financial products for every stage of growth. 

With Nav Prime, small business owners get the most comprehensive toolset to build business credit, track cash flow, and manage financial health. 

And with Nav Cash Flow Health, you can instantly see your cash flow along with projected forecasts.

Frequently Asked Questions About Cash Flow

Is cash flow seen on the profit and loss statement?

While a cash flow statement is different from a profit and loss (P&L) statement, the two reports are linked. Most P&L statements include net profit or loss in the first line of the report, which is what cash flow calculates. You can determine your cash flow from a P&L statement by adding depreciation and net income and then subtracting change in change in working capital and capital expenditure.

What elements make up a profit and loss statement?

A profit and loss (P&L) statement is made up of several line items that document your sales amounts (revenue) and expenses. What line items make up your P&L will depend on your business. At its most basic, a P&L will include: 

• Net sales (revenue)
• Cost of goods sold (COGS)
• Gross margin
• Selling, general, and administrative (SG&A) expenses or operating expenses
•  Net income or profit
• Taxes

Your business may also have other expenses, such as:

• Interest expenses
• Marketing and advertising
• Technology or research and development (R&D)

What elements make up a cash flow statement?

There are three main elements of a cash flow statement: 

• Business operations
• Investing
• Financing

Operating revenue is is the most basic form of revenue for a business and comes from your sales of goods and services. Investing includes any money you’re making off of investments such as the stock market or real estate. Financing is any money that comes from business loans, lines of credit, merchant cash advances, equipment financing, etc.

What is free cash flow?

Free cash flow is the cash a business has to either pay out dividends or pay back creditors. When calculating free cash flow you need to look at your cash flow from operations and then take out the tax shield on interest expenses and capital expenditures while adding back interest expenses. 

Is cash flow the same as profit?

No cash flow is not the same as profit. Cash flow refers to the money that comes in and out of your business, while profit is how much revenue remains after all expenses are deducted. 

What is better cash flow or profit?

Neither cash flow or profit is better than the other, they just both tell you something different about the business. Cash flow is more of a liquidity indicator for a business while profitability is often used to assess how a company is performing overtime and against other companies in the industry.

Why is cash flow lower than profit?

Cash flow is often lower (more outflows than inflows) than profits when you have a business that does more invoicing than point of sale transactions. It also occurs when customers pay slowly. 

With invoices, you still have your everyday expenses (cash outflows) related to selling your goods or services but don’t get the income (cash inflows) or profit until later. This can cause the cash flow to be lower than profit.

How can you be cash flow positive but not profitable?

There are several reasons cash flow could be positive but the business may not be profitable. 

Cash flow is calculated differently than net income. As a result there are several factors that can cause cash flow to be positive but the business to not be profitable:

• New loan
• Accrued expenses
• Depreciation
• Selling assets

What is the relationship between cash flow and profitability?

While cash flow and profitability can certainly correlate with one another they don’t always cause one another. 

Cash flow and profitability are calculated differently, so factors such as getting a new loan will impact cash flow and profitability at different times. On the flip side, there are certainly times where cash flow and profitability move together.  

The previous version of this article was written by Susan Guillory.