Summary
Highlights
Many businesses confuse profit and cash flow, but they are not the same. Over 90% of businesses fail due to running out of cash, not profit. Unprofitable businesses can still survive if they have cash, but a business without cash will inevitably fail.
Cash flow is the movement of money into and out of your business. Positive cash flow means more cash is entering than leaving, which is ideal. Negative cash flow means more cash is leaving than entering. This concept is often confused with profit.
Profit is the financial gain or loss calculated by subtracting incurred expenses from earned revenue. The key difference lies in 'earned' versus 'received' cash and 'incurred' versus 'paid' expenses. You can earn money without receiving cash and incur expenses without immediately paying them, which impacts cash flow.
Business owners often overemphasize the income statement (profit and loss statement), which only shows earned revenue minus incurred expenses. It doesn't reflect the actual cash available to keep the business operating. To understand your financial health, you need to look beyond just profit.
To calculate cash flow, start with your opening cash balance, add all cash inflows, and subtract all cash outflows. Your bank account balance represents your current cash flow reality.
A cash flow statement outlines the cash movement in your business, ideally reviewed monthly. It's typically divided into three sections: operating activities (day-to-day business cash), financing activities (borrowing/lending cash), and investing activities (purchasing/selling assets).
If a cash flow statement isn't available, review your profit and loss statement on a cash basis. Accrual basis looks at earned revenue and incurred expenses regardless of cash movement, while cash basis directly accounts for cash received and paid, giving a better picture of your cash position.
To bridge the gap between profit and cash flow, first, understand your current cash flow. Second, increase the speed of collections by using electronic payments. Third, decrease the speed of payments by negotiating longer payment terms with vendors, though this should be a last resort.
Profit is about earned revenue and incurred expenses, while cash flow is the actual movement of cash in and out of the business. To understand cash flow, regularly review your cash flow statement or a cash-basis profit and loss statement. Understanding this distinction is vital for business survival and growth.