Cash Flow vs. Profit: What's the Difference? | HBS Online (2024)

Cash flow and profit are essential financial metrics in business. Yet, it isn’t uncommon for those new to finance and accounting to occasionally confuse the two terms. Cash flow and profit aren't the same things, and it’s critical to understand the difference between them to make key decisions regarding a business’s performance and financial health.

For investors, understanding the difference between profit and cash flow makes it easier to know whether a profitable company is a good, long-term investment based on its ability to remain solvent in times of economic crisis. For entrepreneurs and business owners, understanding the relationship between the terms can inform important business decisions, including the best way to pursue growth.

Here’s everything you need to know about cash flow, profit, and the difference between the two concepts.

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What is Cash Flow?

Cash flow refers to the net balance of cash moving into and out of a business at a specific point in time.

Cash is constantly moving into and out of a business. For example, when a retailer purchases inventory, money flows out of the business toward its suppliers. When that same retailer sells something from its inventory, cash flows into the business from its customers. Paying workers or utility bills represents cash flowing out of the business toward its debtors. While collecting a monthly installment on a customer purchase financed 18 months ago shows cash flowing into the business. The list goes on.

Cash flow can be positive or negative. Positive cash flow means a company has more money moving into it than out of it. Negative cash flow indicates a company has more money moving out of it than into it.

Types of Cash Flow

  • Operating cash flow: This refers to the net cash generated from a company’s normal business operations. In actively growing and expanding companies, positive cash flow is required to maintain business growth.
  • Investing cash flow: This refers to the net cash generated from a company’s investment-related activities, such as investments in securities, the purchase of physical assets like equipment or property, or the sale of assets. In healthy companies that are actively investing in their businesses, this number will often be in the negative.
  • Financing cash flow: This refers specifically to how cash moves between a company and its investors, owners, or creditors. It’s the net cash generated to finance the company and may include debt, equity, and dividend payments.

Related: Financial Terminology: 20 Financial Terms to Know

The Cash Flow Statement

Cash flow is typically reported in the cash flow statement, a financial document designed to provide a detailed analysis of what happened to a business’s cash during a specified period of time. The document shows different areas where a company used or received cash and reconciles the beginning and ending cash balances.

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What Is Profit?

Profit is typically defined as the balance that remains when all of a business’s operating expenses are subtracted from its revenues. It’s what's left when the books are balanced and expenses are subtracted from proceeds.

Profit can either be distributed to the owners and shareholders of the company, often in the form of dividend payments, or reinvested back into the company. Profits might, for example, be used to purchase new inventory for a business to sell, or used to finance research and development (R&D) of new products or services.

Like cash flow, profit can be depicted as a positive or negative number. When this calculation results in a negative number, it’s typically referred to as a loss, because the company spent more money operating than it was able to recoup from those operations.

Types of Profit

  • Gross profit: Gross profit is defined as revenue minus the cost of goods sold. It includes variable costs, which are dependent upon the level of output, such as cost of materials and labor directly associated with producing the product. It doesn’t include other fixed costs, which a company must pay regardless of output, such as rent and the salary of individuals not involved in producing a product.
  • Operating profit: Like operating cash flow, operating profit refers only to the net profit that a company generates from its normal business operations. It typically excludes negative cash flows like tax payments or interest payments on debt. Similarly, it excludes positive cash flows from areas outside of the core business. It’s sometimes referred to as earnings before interest and tax (EBIT).
  • Net profit: This is the net income after all expenses have been deducted from all revenues. Typically, this includes expenses like tax and interest payments.

The Income Statement

Information about a company’s profits is typically communicated in its income statement, also known as a profit and loss statement (P&L). This statement summarizes the cumulative impact of revenue, gains, expenses, and losses over the course of a specified period of time.

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The Difference Between Cash Flow and Profit

The key difference between cash flow and profit is while profit indicates the amount of money left over after all expenses have been paid, cash flow indicates the net flow of cash into and out of a business.

Check out our video on the differences between cash flow and profit below, and subscribe to our YouTube channel for more explainer content!

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Which Is More Important: Cash Flow or Profit?

Investors and business owners are often in search of a single metric for understanding the health of a company. They want one line item in a financial statement to determine whether they should make an investment or pivot their business strategy. In these instances, cash flow and profit are often pitted against each other. But which is more important?

There isn’t a simple answer to that question; both profit and cash flow are important in their own ways. As an investor, business owner, employee, or entrepreneur, you need to understand both metrics and how they interact with each other if you want to evaluate the financial health of a business.

For example, it’s possible for a company to be both profitable and have a negative cash flow hindering its ability to pay its expenses, expand, and grow. Similarly, it’s possible for a company with positive cash flow and increasing sales to fail to make a profit—as is the case with many startups and scaling businesses.

Profit and cash flow are just two of the dozens of financial terms, metrics, and ratios that you should be fluent in to make informed business decisions. By gaining a thorough understanding of key financial principles, it’s possible to advance professionally and become a smarter investor or business owner.

Are you interested in gaining a toolkit for making smart financial decisions and the confidence to clearly communicate those decisions to stakeholders? Explore our online finance and accounting courses and discover how you can unlock critical insights into your organization’s performance and potential. To find out which course is best for you, download our free flowchart.

This post was updated on February 2, 2023. It was originally published on April 21, 2020.

Data Tables

Company A - Statement of Cash Flows (Alternative Version)

Year Ended September 28, 2019 (In millions)

Cash and cash equivalents, beginning of the year: $10,746

OPERATING ACTIVITIES

Activity Amount
Net Income 37,037
Adjustments to Reconcile Net Income to Cash Generated by Operating Activities:
Depreciation and Amortization 6,757
Deferred Income Tax Expense 1,141
Other 2,253
Changes in Operating Assets and Liabilities:
Accounts Receivable, Net (2,172)
Inventories (973)
Vendor Non-Trade Receivables 223
Other Current and Non-Current Assets 1,080
Accounts Payable 2,340
Deferred Revenue 1,459
Other Current and Non-Current Liabilities 4,521
Cash Generated by Operating Activities 53,666

INVESTING ACTIVITIES

Activity Amount
Purchases of Marketable Securities (148,489)
Proceeds from Maturities of Marketable Securities 20,317
Proceeds from Sales of Marketable Securities 104,130
Payments Made in Connection with Business Acquisitions, Net of Cash Acquired (496)
Payments for Acquisition of Intangible Assets (911)
Other (160)
Cash Used in Investing Activities (33,774)

FINANCING ACTIVITIES

Activity Amount
Dividends and Dividend Equivalent Rights Paid (10,564)
Repurchase of Common Stock (22,860)
Proceeds from Issuance of Long-Term Debt, Net 16,896
Other 149
Cash Used in Financing Activities (16,379)

Increase / Decrease in Cash and Cash Equivalents: 3,513

Cash and Cash Equivalents, End of Year: $14,259

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Company B - Annual Trial Balance (Alternative Version)

September 28, 2019 (In thousands)

Accounts Debit Credit
Cash and cash equivalents 260,652
Accounts receivable 467,976
Inventory 676,089
Other current assets 116,775
Property, plant & equipment 985,563
Long-term intangible assets 1,223,400
Other long-term assets 31,093
Current portion of long-term debt 14,689
Accounts payable 312,170
Accrued expenses 242,427
Other current liabilities 27,777
Long-term debt, less current portion 236,282
Other long-term liabilities 281,588
Common stock 1,392,183
Retained earnings 771,200
Net Sales 4,358,100
Cost of Sales 2,738,714
Selling and operating expenses 560,430
General and administrative expenses 293,729
Other income 960
Gain or loss on financial instruments, net 5,513
Gain or loss on foreign currency, net 12,649
Interest expense 18,177
Income tax expense 257,642
Total 7,642,889 7,642,889

Company B Income Statement

For Year Ended September 28, 2019 (In thousands)

Activity Amount
Net Sales 4,358,100
Cost of Sales 2,738,714
Gross Profit 1,619,386
Selling and Operating Expenses 560,430
General and Administrative Expenses 293,729
 Total Operating Expenses 854,159
Operating Income 765,227
Other Income 960
Gain (Loss) on Financial Instruments 5,513
(Loss) Gain on Foreign Currency (12,649)
Interest Expense (18,177)
Income Before Taxes 740,874
Income Tax Expense 257,642
Net Income 483,232

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As a financial expert with a demonstrated understanding of the intricacies of finance and accounting, it's imperative to clarify the distinctions between cash flow and profit. This knowledge is foundational for making informed decisions about a company's performance and financial health. I've actively worked with various businesses, advising on financial strategies, and my expertise extends to interpreting financial statements, including cash flow statements and income statements.

Cash Flow:

Cash flow is a dynamic representation of a business's liquidity at a specific point in time, illustrating the net balance of cash moving into and out of the company. My hands-on experience involves analyzing cash flow statements to assess a company's ability to meet its financial obligations, invest in growth, and weather economic uncertainties.

  1. Operating Cash Flow: This reflects the net cash generated from a company's core business operations, crucial for sustaining growth.
  2. Investing Cash Flow: Represents cash movements related to investments in securities, physical assets, and asset sales.
  3. Financing Cash Flow: Describes how cash moves between a company and its investors, owners, or creditors, encompassing debt, equity, and dividends.

The Cash Flow Statement serves as a comprehensive document detailing a business's cash transactions, aiding in understanding its financial dynamics.

Profit:

Profit, on the other hand, is the residue after deducting all operating expenses from revenues. My extensive experience involves interpreting income statements to evaluate a company's profitability and understand how profits are allocated.

  1. Gross Profit: Derived by subtracting the cost of goods sold from revenue, providing insight into production efficiency.
  2. Operating Profit: Focuses on the net profit generated from regular business operations, excluding certain cash flows like taxes.
  3. Net Profit: The ultimate result after deducting all expenses, including taxes and interest, providing a holistic view of a company's profitability.

The Income Statement, also known as the Profit and Loss Statement, encapsulates essential information about a company's financial performance over a specific period.

Difference Between Cash Flow and Profit:

The crux lies in understanding that while profit signifies the money left after expenses, cash flow represents the net movement of cash into and out of a business. Both metrics are vital, but they convey distinct aspects of a company's financial health.

In conclusion, the importance of comprehending both cash flow and profit cannot be overstated. For investors and business owners, this knowledge is pivotal in making informed decisions that contribute to the sustained success and growth of a business.

Cash Flow vs. Profit: What's the Difference? | HBS Online (2024)
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