Cash Flow vs Profit Simplified With an Example
Have you experienced a moment, when you looked at your financials and noticed that your bank balance is way more or less compared to your profits in that month?
And in such a moment did you get really confused why that was?
Unsure about whether it was good or bad, whether your business was doing well or not?
If yes, then this article is for you.
By the end of this article, you will know exactly what is the difference between cash flow and profit, what does this mean to you as an entrepreneur.
You will also know how by understanding this difference you can grow your business.
Let’s begin.
Profit vs Cash Flow
Business is a marathon and also an intellectual game.
In order to play the game right and be in the business long enough, you need cash flow which is like stamina. With this stamina, you improve your score in the game of business, by generating profits.
Think about it, if you want to hire an extra pair of hands, you need cash. You can’t spend profit on it.
Just because you have a great skill in a sport, doesn’t mean, you will win, if you don’t have the stamina to play the game for the entire duration. When you have the stamina you can score using that skill. So you need the stamina to go on, and the skill to play well.
Let’s see how cash flow and profit are related, and are two sides of the same coin in business, in a very simple way with an example.
How Cash Flow and Profit Are Related
For this, I’d like you to meet Heather, founder of Mega Profit Limited.
In 2019, her business did $500,000 in sales.
As of December 2019 for the financial year, Mega Profit Limited generated a Net Profit of $100,000 and a cash balance of $80,000 on this $500,000 in sales.
On 31st March 2020, her accountant prepared financial statements and it looked like this.
Let’s look at the month of January 2020.
Although the sales in the month were $250k, Heather’s business only collected $187.5k in cash in January, leaving $62.5k unclaimed.
In terms of cash outflow, although costs and expenses incurred were $175k, cash outflow was $100k which possible was because of paying for the previous month’s balance plus paying for this month.
This leaves Heather’s Mega Profit Limited with a cash flow balance of $167.5k which is an opening bank balance of $80k plus $187.5 cash inflow and $100k cash outflow.
When you following the same process for the month of February and March 2020, we end up with:
Cash balance of $120k. Running profit balance of $137.5k
Looking at this Heather wondered why her profit is:
$137.5k which is ($75k +$25k +$37.5k)
And, the cash balance is $120k. So there’s a difference of $17.5k, which is tied up into combinations of debtors and creditors.
Now you know the difference between cash flow and profit and why they are different.
Did it get you thinking — profit vs cash flow — which is more important?
Let me answer this by asking you a question.
When playing a sport, which is more important? Stamina or skill?
We discussed this before. You need both.
I’ll leave you with the formula to have both.
Formula To Have Both Profit and Cash Flow
If you got value from this article then don’t forget to clap for it.
If you like videos more than words, then I published a video with the same content, you might want to check it out below.
