What's More Important, Cash Flow or Profits? (2024)

Cash flowandprofitsare both crucial aspects of a business. For a business to be successful in the long term,it needs togenerate profits while also operating with positive cash flow.

What Is Cash Flow?

Cash flow is the inflow and outflow of money from a business. It is necessary for daily operations, taxes, purchasing inventory, and paying employees and operating costs.

Positive cash flow indicates that a company'sliquid assetsare increasing. This enables it to settledebts, reinvest in its business, return money to shareholders, pay expenses, and provide a buffer against future financial challenges.Negative cash flow indicates that a company's liquid assets are decreasing.

What Is Profit?

Profit is the surplus after all expenses are deducted from revenue. Profit is the overall picture of a business and the basis on which tax is calculated.

There are three major types of profit that analysts analyze: gross profit, operating profit, and net profit. Each type of profit gives the analyst more information about the company's performance, especially when compared against other time periods and industry competitors. All three levels of profitability can be found on the income statement.

Which One IsMore Important to a Business?

When determining which one is more important, it depends on the business and the circ*mstances.

For example, a business may see a profit every month, but its money is tied up in hard assets or accounts receivable, and there is no cash to pay employees. Once a debt is paid, or the business sees an influx in revenue, it starts to see positive cash flow again. In this example, cash flow is more important because it keeps the business running while still maintaining a profit. Alternately, a business may see increased revenue and cash flow, but there is a substantial amount of debt, so the business does not make a profit.

The absence of a profit eventually has a declining effect on the cash flow. In this instance, profit is more important. Another thing to remember when determining whether to focus on cash flow or profit is cash flow can be bought. A business owner can put up his or her personal assets as capital into the business. Alternatively, they can get a small business loan from a bank to keep the business running until it starts seeing cash flow again.

What's More Important, Cash Flow or Profits? (2024)

FAQs

What's More Important, Cash Flow or Profits? ›

There are a couple of reasons why cash flows are a better indicator of a company's financial health. Profit figures are easier to manipulate because they include non-cash line items such as depreciation ex- penses or goodwill write-offs.

How can you be cash flow positive but not profitable? ›

Sometimes, a business can be cash-flow positive but may not be profitable For instance, if a business operates at a net loss, borrowing cash helps create a positive cash flow. Similarly, when it sells a significant asset to raise capital, the money it receives is an inflow of cash.

Is cash flow statement the most important? ›

The Bottom Line

A cash flow statement is a valuable measure of strength, profitability, and the long-term future outlook of a company. The CFS can help determine whether a company has enough liquidity or cash to pay its expenses. A company can use a CFS to predict future cash flow, which helps with budgeting matters.

Is cash flow more important than net worth? ›

Whether you are a fake retiree, a traditional retiree living off Social Security, or someone with a day job, cash flow is more important than net worth, especially during an economic downturn. Net worth is often an illusion that only helps to boost your ego when times are good.

Which is more important net income or operating cash flow? ›

In the long run, high operating cash flow brings a stable net income rise, though some periods may show net income decreasing tendency. Constant generation of cash inflow is more important for a company's success than accrual accounting. Cash flow is a better criterion and barometer of a company's financial health.

Can a company generate profit but have a negative cash flow? ›

Yes, a profitable company can have negative cash flow. Negative cash flow is not necessarily a bad thing, as long as it's not chronic or long-term. A single quarter of negative cash flow may mean an unusual expense or a delay in receipts for that period. Or, it could mean an investment in the company's future growth.

Does cash flow equal profit? ›

So, is cash flow the same as profit? No, there are stark differences between the two metrics. 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.

How do companies survive without profit? ›

A company can get by on high revenues and low or non-existent profits if investors believe that it will become profitable in the future. Amazon is just one example of a company that did that by focusing on growth and revenue rather than profit.

Is cash flow the same as profit and loss? ›

Both concepts are important parts of a successful financial planning. Cash flow is important because it shows how much money a business has available to meet its obligations. Profit and loss, on the other hand, is a measure of whether a business is making money or not.

What are the disadvantages of cash flow statement? ›

As a cash flow statement is based on a cash basis of accounting, it ignores the basic accounting concept of accrual. Cash flow statements are not suitable for judging the profitability of a firm, as non-cash charges are ignored while calculating cash flows from operating activities.

Why is cash flow lower than profit? ›

Your company is buying equipment, products, and other long-term assets with cash (Cash Flows From Investments). As a growing small business, you are likely to be spending more than you have in profits because the company is investing in long-term assets to fuel its expansion.

How much cash flow is enough? ›

When it comes to cash-flow management, one general rule of thumb suggests enough to cover three to six months' worth of operating expenses. However, true cash management success could require understanding when it might be beneficial to invest some cash elsewhere as well.

Is too much cash flow bad? ›

Excess cash has three negative impacts: It lowers your return on assets. It increases your cost of capital. It increases business risk and destroys value while making the management overconfident.

How do I convert profit into cash flow? ›

To convert your accrual net profit to cash, you must subtract an increase in accounts receivable. The increase represents income that has been recorded but not yet collected in cash. A decrease in accounts receivable has the opposite effect — the decrease represents cash collected, but not included in income.

Why is profit not the same as cash? ›

Understanding the difference between profit vs cash is very important in the finance industry. Profit is defined as revenue less all the expenses of a company in a certain period, while cash flow is cash that flows in and out to/from a business throughout a certain period of time.

Why would business owners choose to reinvest profits? ›

For companies that reinvest their profits, the benefit is simple: It can help improve the business. If business is booming, you could use those profits to support expansion to accommodate an increase in anticipated volume.

Is cash flow positive the same as profitable? ›

Profit is defined as revenue less expenses. It may also be referred to as net income. Cash flow refers to the inflows and outflows of cash for a particular business. Positive cash flow occurs when there's more money coming in at any given time, while negative cash flow means there's more money out.

Is a positive cash flow enough to tell whether a company is profitable? ›

Profitability does not necessarily equal positive cash flow. Alternatively, positive cash flow does not necessarily mean the business is profitable. To be financially successful over time, profitability should provide enough funds for the investing and financing needs of the business.

Can a firm that has positive profits still be running out of cash? ›

Yes, it is possible for a firm to have a positive net income and still run out of cash. This situation is possible, especially where the firm is spending a lot of cash in financing activities. For example, a company can be involved in paying back huge loans that could have been obtained in prior years.

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