Money makes the world go round, but by what measurement?
For businesses, money is more complex than what they happen to have in the bank. That’s why metrics like cash flow and profit are used to indicate a company’s financial success. But what do those terms mean?
In this guide, we explain cash flow, profit, and the basics of cash flow management.
What is Cash Flow?
Cash flow is the measure of how much money goes into or out of your business in a period of time.
Extending the metaphor of the “flow” part of the term, cash flow acts just like a river. When water flows into a river, the river runs strong. When there’s a drought, the river slows to a trickle—the perfect analogy for your business accounts.
The importance of cash flow in business is no different from that of your personal cash flow. You probably know the date of your payday off by heart, as well as the dates on which you need to pay the bills. That’s because you need to know when you have cash, not just whether you have it.
Cash flow forecasting allows a company to predict when its cash reserves will ebb and flow. Stable, predictable cash flow is the essential foundation of a healthy business.
What is Profit?
Profit and loss is a way of measuring the overall amount of money coming into the business. This is usually divided into an arbitrary time period (e.g. yearly profit) but this periodisation isn’t the focus as it is for cash flow.
Profit is simply all of the money a business makes minus its expenditure.
While cash flow is the lifeblood of your business, profit is the primary metric that measures a company’s ability to grow. Large profits indicate that a business is pulling in revenue that eclipses its overheads. This means the company has money to spend on other projects or investments, or simply on expanding its operations.
Cash Flow vs Profit
So which is more useful, cash flow or profit? Well, it’s both, because they measure different things.
Think of cash flow and profit as like the human diet. Your cash flow is what you eat every day—it powers your body. If you don’t eat enough in a day, you’ll get hungry and weak. Your profit is the sum of all the calories you eat. This determines whether you lose or gain weight over time.
Taken to extremes, you can see why the two measures are both important. If you ate all you could in the first six months of the year, you would still starve if you ate nothing more for the rest of the year.
This is why both metrics are important for figuring out the health of a business. A business needs cash flow to survive, but it also needs profit to grow. Without cash flow, a business “starves” as it fails to meet its obligations like paying employees and property leases. Without profit, a business either fails to grow or begins to shrink.
Cash Flow Management and Profit Made Simple
With the details we’ve spelt out here, you can see why profit and cash flow management are both important for a business. Be sure to measure both and weigh them against each other—a rounded view is essential for determining the health of a business.
