Knowing the Difference between Profitability and Cash Flow

Profitability and cash flow are both important metrics in figuring out how well your company is doing, but many people do not understand the subtle differences between what they mean and what they can tell you about the financial health of your business.

While both are crucial measures of your company’s financial resources, they are not the same concept, and understanding what they each mean can be the deciding factor in the success – or failure – of your business, and ultimately of your personal finances.

Cash Flow

Everyday your company receives a certain amount of money in, and must pay some amount of money out to cover expenses.

Cash flow refers to the difference between the money received and the money spent for business purposes. It refers to when a company needs money in order to pay salaries, purchase supplies, and cover the costs of utilities and other business operation expenses.

Analysts must keep a close eye on their cash flow in order to ensure that the business will be able to continue operation. Companies with poor cash flow will likely need to secure a loan in order to pay their expenses while their revenue catches up.

Unfortunately, this puts you in a negative personal financial situation. Although the loan will primarily be associated with your company, it can still effect your personal credit. If your company doesn’t have a healthy amount of cash flow, you should consult a bankruptcy trustee as soon as possible to ensure you can get on the right path before digging too deep a hole.

Profitability

This metric refers to whether or not a company is actually making money.

Profit is calculated by taking the revenue received from selling goods or providing services to customers, and subtracting the total expenses of the company.

This allows analysts to easily find out if they company is earning income by bringing in more money than it spends. They will also use this information to track profit over time and determine the consistency of their income.

A common form of accounting known as accrual-basis accounting tracks every single transaction including sales, profits, and expenses. These transactions are recorded at the time of the deal even if the actual money has not yet changed hands.

This is one of the biggest differences between how analysts look at and use cash flow and profitability: cash flow deals specifically in the timing of money changing hands while profitability focuses on the numbers.

Businesses often run into problems when their cash flow and profitability do not line up. A company might be making lots of profit, but if money is not changing hands in time for the company to pay their bills, they will begin to suffer from cash flow problems and may need to consider a loan.

It is also possible for a company to have healthy, consistent cash flow without actually making money. When Amazon sold their stock in the mid-90s, they made so much money that they had a healthy $2B in the bank. Even though they spent more money than they made each year, they had the cash to cover their expenses for nearly a decade before they needed to make a profit.