As your small business grows, you may notice that you’re becoming more profitable. However, you also seem to be running out of cash.
This is a common occurrence in business growth. Often, profitability is confused with cash flow in the business world. Cash flow is not profit and these two measurements each tell you something different about your business.
The Difference Between Cash Flow & Profit
Cash flow and profit are two different things. Cash is the difference between the cash you have at the beginning of the period and the end of the period.
Profitability, on the other hand, is what’s left over after deducting business expenses from the income you generate.
How You Calculate Profitability
The first step to understanding cash flow v. profit in your small business is to look at some basic terminology.
A balance sheet is the measurement of a company’s resources, including cash. Typically, a balance sheet has three components: assets, liabilities and equity.
Profit & Loss is how your business measures its profitability. This is done through sales, costs of goods, operating expenses and other income/expenses.
You get to profitability by deducting your expenses from your income.
SALES – COSTS OF GOODS SOLD – OPERATING EXPENSES ± OTHER INCOME/EXPENSES = NET INCOME (PROFITABILITY)
How to Calculate Cash Flow
At its simplest form, cash flow equals the cash changes in assets, liabilities and equity. Cash flow is provided or used by various activities of the business. The activities are broken into three categories: operating, investing, and financing.
All of this goes into the cash flow of your small business.
Examples of Cash Flow V. Profitability
Here are a few ways cash flow can differ from profitability in your business.
Why Understanding Cash Flow v. Profit Matters
Each of these terms and their corresponding metrics tells you something about your business. But they’re not the same and it’s important not to confuse them. You can have profitability without adequate cash flow. You can also have a steady cash flow and not be profitable.
Understanding the difference helps you know what’s happening in your business and can show you ways to solve problems you may be facing.
Still unsure? Utilize a trusted advisor to help outsource some of these functions of your business. Here are a few reasons to consider outsourcing.
Want to know more about the basics of accounting?Download our Accounting 101 Whitepaper