Cash vs Profit: Why cash flow is more important to a small business

Many businesses make the mistake of equating profit with cash flow — but in reality, these concepts are pretty distinct. Here’s a primer on cash flow vs. profit and why you should be making cash flow your priority.

3 min read

At its simplest, cash flow is the amount of money flowing into your business at any point in time. Profit is the money you have made after you have deducted all of your business expenses. Both are important performance measures, but out of the two, cash flow has a more significant impact on the success of your business. Let us explain why.

Cash flow vs profit vs revenue: what is the difference?

What is cash flow?

Cash flow is the money that is moving in and out of your business at any given time. Cash comes in from sales, collecting on accounts receivable, and any other business activities. Cash goes out as expenses, costs and other accounts payable.

Cash flow is the lifeblood of a business because it helps day-to-day operations. It affects the rate and amount of business growth, the efficiency and effectiveness of running your business, and when (or whether) you pay business costs and expenses.

How to calculate cash flow?

Cash flow = cash from operating activities +(-) cash from investing activities + cash from financing activities

Formula how to calculate cash flow

Read more: How to perform a quick cash flow analysis in 4 steps

What is profit? 3 types and how to calculate them

Profit is the financial gain to your business when you factor in costs. When people talk about profit, they could be referring to any of these types:

Gross profit

Refers to the profits earned after subtracting the costs of producing and distributing the products. You can calculate gross profit when you subtract the cost of goods sold (COGS) from your revenue.

Operating profit

The revenue earned through your business activities minus the COGS, as well as operating expenses, depreciation, and amortisation (which means spreading payments over multiple periods).

Net profit

The most accurate metric of how much money you are making in terms of numbers. It is your revenue minus all business expenses and costs. However, just looking at net profit can be misleading as well. A business may look like it is generating lots of cash because it has made smart market investments at the right time — but may actually have falling sales on core products.

What is revenue?

Revenue refers to the money a business earns from its products or services, whereas cash flow looks at what is coming in and going out. Revenue measures how successful your sales and marketing efforts are. Whereas cash flow tells you whether your revenue and business practices are enough to stay in business or make a profit.

Why cash flow is more important than profit

If you are generating lots of income on paper, but you have a cash flow problem, your business will likely be in trouble. Inadequate cash flow is one of the top reasons businesses fail — especially if you're a small business.

Read more: Common cash flow problems (and how to solve them)

If you can't pay your bills and meet your obligations, your revenue isn’t as important as you might think. You may be bringing in profits in the form of accounts receivable or assets, but if you can't quickly convert those into cash, your business may not be viable.

For seasonal businesses, it is crucial to manage cash flow, since the income of the business may fluctuate significantly at different times of the year.

Improve cash flow with Direct Debit

One of the most effective ways to improve cash flow is having the ability to take recurring payments automatically. By offering your customers convenient and effective payment methods — such as signing them up for Direct Debit — you are more likely to be paid right away instead of waiting on late payments.

Read more: Consulting business Revealed Resources has cash flow mastered

Just as your business benefits from regular income, your customers tend to find personalised payment schedules and more ‘bite-sized’ payments much easier and convenient. Direct Debits are also great for administration purposes, as it’s paperless and easily tracked.

Download your quick guide to Direct Debit

Equally as effective, is being able to take payments in a variety of ways and have it all reconciled in one system for easy reporting and management. As an omni-channel payments provider, we offer EFTPOS, BPAY and online and over-the-phone payments (in addition to Direct Debit) so your business has more ways to get paid — and a better chance of improving your cash flow.

Want to know more? Contact us and let us take the pain out of your payments.

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