Cash Flow-Positive vs. Profitability: What’s the Difference?

Forty seven American dollars on a table

When you see that your company is cash flow-positive, you might be quick to assume that your business is profitable, but don’t pop the champagne just yet! While the cash flow and profits of your business are closely related, they are not technically the same thing.

However, since both your cash flow and profits play a huge role in the survival of your business, it is extremely important that you understand how they actually differ. Luckily, we are here to break it down for you.

Cash Flow-Positive vs. Profitability

When your company is cash flow-positive,it means your cash inflows exceed your cash outflows. Profit is similar: For a company to be profitable, it needs to have more money coming in than it does going out. So when you see that you have more receivables than you do payables, it can be easy to assume that your business is making a profit. But that’s not always the case.

Your business can be profitable without being cash flow-positive—and you can have a positive cash flow without actually making a profit.

Here’s how to see if you’re cash flow-positive:

Your cash flow is the money coming in and out of your business on any given day. This working capital is what you use to cover your business expenses, such as payroll, rent, inventory purchases, and so on. Simple, right?

Your profit, on the other hand, is really only an accounting term that exists on paper. This measurement gives you a basic idea of how much money you have coming in and going out of your business each month, but what it doesn’t do is tell you much about your day-to-day operations.

Keep in mind that many businesses use accrual accounting, which means your revenue and expenses are recorded, regardless of whether or not cash has been exchanged.

For example, let’s say you send out an invoice for $1,000. This $1,000 will be recorded on your profit and loss statement as a profit—even if you don’t receive payment for said invoice right away.

This difference is key when your bills come up as due. If you’re still waiting for payment on that invoice, you may not have enough cash on hand to cover the costs, and not having the cash makes you cash flow-negative. However, since profit doesn’t tell you exactly when money is coming in and going out of your business, you will still appear profitable on paper, even if that isn’t in the bank for you to use.

How to Calculate Your Cash Flow

In order to calculate your cash flow, you have to know how much money your business is starting out with on the first of the month. Your “cash on hand” should include exactly that—the cash you have on hand that is readily available to use.

Once you know how much you’re starting with, you’ll subtract all your operating expenses, investment activities, and financing activities. Remember, we are talking about your actual cash flow, so this will not include any unpaid debt or outstanding invoices.

Let’s say you have 5 customers and you send five invoices every month. Let’s also assume your average invoice value is $2000 and you payment terms are NET21. To complete our assumptions, we’ll assume your Cost of Goods Sold (COGS) is 50% of your billed amount and that your operational costs are flat at $3000 per month (including rent, employees/contractors, insurance, etc). In this case your cash flow chart may look something like this (not taking in to account prior balance or actual cash on hand, for simplicity):

Example: Cashflow Calculator

Cash Flow Chart

Cash Flow Chart Month1Month2
Issued Invoices 55
Value Per Invoice $2000 $2000
Paid Invoices 05
Booked Revenue $10000 $10000
Actual Income $0 $10000
COGS-$5000 -$5000
Operational Costs -$3000 -$3000
Monthly Net Profit$2000$2000
Monthly Cash Flow-$8000$2000
Running Cash Flow-$8000-$6000

As you can see, the key difference between your cash flow balance and profitability is that cash flow represents actual In/Out funds in a given period. Profit usually looks at booked, planned income and expense in a given period. Because of that Profitability may be a bit misleading. Especially for businesses that get paid on NET terms.

Therefore, if you sent that $1,000 invoice out but it is yet to be paid, you will not count it as a cash inflow. Instead you’ll mark it as “collections or accounts receivables” until the invoice is paid. Or, let’s say you purchase something with a business credit card, but don’t pay it off right away. The balance you owe on your card will not count as a “cash outflow” until the debt is actually paid.

After your calculations, if your closing balance adds up to be greater than your starting balance, your cash flow is positive. If it adds up to be lower, your cash flow is negative.

How to Calculate Your Profitability

There are two components to calculating your profitability: your gross profit and your net profit. Your gross profit is your revenue, minus the cost of goods sold (COGS). Your net profit is your gross profit minus your operating expenses.

Gross Profit

Let’s say you own a bookstore and bring in $10,000 of revenue for the month of October, but the books cost you $5,000. Your gross profit would be $5,000.

Gross Profit$5,000

Your gross profit is what you make off your book sales, but this calculation does not include the other costs associated with running a business, such as payroll, rent, marketing, and so on. In order to figure out your total profitability, you need to calculate your net profit.

Net Profit

If your total operating expenses for the month cost you a total of $3,000, your net profit, or your take home money, would be $2,000.

Gross Profit $5,000
Operating Expenses -$3,000
Net Profit$2,000

As you can now see more clearly, even though your cash flow and profits are related, they are not completely synonymous. Your profitability takes a look at your accounting and gives you a general overview of the bigger picture of your business’s finances. Your cash flow calculations, on the other hand, monitor your receivables and payables in real time, giving you an ongoing understanding of your monthly financial situation so you can keep operating your business from day to day.

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Tags: Accounting and TaxFinancing