Cash Flow vs. Profit
“It doesn’t matter how much revenue you are owed, if you don’t have cash flow, you can’t keep a business afloat,” says Marty McCaffrey, founder of Ledger General, an accounting, tax and advisory services firm in Chicago.
For small businesses, cash is king. When there’s money in the bank, it can feel like business is booming. And when it’s not, tough sacrifices may need to be made.
This is where many small businesses make mistakes. “Unless business owners come from a financial background, many assume that all cash flow is profit,” McCaffrey says. “But cash flow and profit are not the same thing.” Understanding the difference could save your business.
WHAT IS CASH FLOW?
“Cash flow is simply the money flowing through the business,” explains Suzanne Vanzant-Ladas, co-owner of ABCD Accounting, a public accounting firm in Miami, Florida. It is defined as the difference between the amounts of cash coming into and out of your accounts during a specific period of time. Cash flow is tracked in a cash flow statement that records all sources of cash received and spent over that time.
The statement should be organized under three categories:
- Cash from operations – includes all revenue generated and all operating expenses including depreciation of assets.
- Cash from investment – includes any cash acquired or used for the purchase or sale of assets or other investments.
- Cash from financing – covers cash flow related to transactions for long-term funding, including the sale or repurchase of company stocks, and debt repayment.
The sum of all three categories is your cash flow for that period.
“Cash flow is used to determine how well the business manages its short term cash and how well it can pay its bills,” says Robert Allman, co-owner of ABCD Accounting. American Express has payment solutions that allow you to maximize your cash flow and hold onto your money longer with up to 55 interest-free days(1) on purchases.
WHY IS CASH FLOW IMPORTANT?
Though cash flow alone doesn’t tell you the whole financial story. Revenue payments are typically made months after goods are manufactured and sold, or services are rendered. Similarly, purchases made on credit won’t impact cash flow immediately, but will affect future cash flow and bottom line results.
With Supplier Payment Solutions from American Express, you can consolidate payments and boost relationships by ensuring suppliers are paid on time or early – while improving your own cash flow.
A company’s profitability, when viewed in combination with cash flow, provides a clearer and more accurate picture of financial health.
WHAT IS THE DIFFERENCE BETWEEN GROSS AND NET PROFIT?
Gross profit is the revenue you make on a specific product or service by subtracting the cost of producing that good from the revenue generated. If a widget costs $50 to make and you sell it for $100, your gross profit is $50.
Gross profit is a useful tool to see which of your products or services are most profitable, how much profit you are making off of these products, and where in your business revenue is being generated (or lost). However, gross profit is not a measure of your company’s profitability.
“Net profit is the number that tells you whether your business is profitable or losing money,” says Jane Spradlin, shareholder with Concannon Miller, a tax and accounting firm in Bethlehem, Pennsylvania.
Net profit is determined by calculating your gross revenue during a specific period, then subtracting all operating costs, including cost of goods sold, payroll, rent, utilities, taxes, loan repayments, and any other expenses paid. “That is how you find your bottom line,” she says.
Looking for other ways to reduce or offset business costs is another way to improve net profit. For example, using a credit card that earns rewards with flexible redemption options such as an American Express Small Business Card is a great way to put more back into your business by offsetting expenses with statement credits.(2)
HOW DO I CALCULATE MY PROFIT MARGINS?
A company’s net profit margin is the percentage of profit it is making on the sale of all goods and services, after subtracting all costs. You can determine profit margin by dividing net profit (see above) by the amount of revenue generated.
For example, if your company generates $100,000 in revenue during a specific period, and spends $80,000 in expenses, the formula is: (100,000-80,000) ÷ 100,000 = 20% profit margin.
“Understanding profit and profit margins tells you whether your business is viable,” McCaffrey says. Business owners can also use these numbers to set competitive product prices, determine salaries, and to support decisions to hire more people or invest in equipment or property. “If you know you are profitable you know what you can afford to do.”
Both cash flow and profit are important measures of financial status for a business, but each one provides a different perspective on the financial health of the business. “Cash flow is how you pay your bills on a day to day basis,” Vanzant-Ladas says. “While profit is an indicator of success.”
Want to learn about payment solutions that could increase cash flow and also help put more back into your business?
Speak to an American Express Representative today or visit AMERICANEXPRESS.CA/PARTNERSHIPS
This article is intended for general informational purposes only and does not constitute legal advice or an opinion on any issue. It should not be regarded as comprehensive or a substitute for professional advice.
1. As a charge Card, the balance must always be paid in full each month in which no interest charges will apply. The interest-free grace period is 28, 29, 30 or 31 days from the closing date of the current statement to the closing date of the next statement depending on the number of days in the calendar month in which the closing date occurs. The number of interes-free days varies based on a variety of factors, including when charges are posted to your account, whether your account is in good standing, and the closing date of your statement.
2. You can redeem Membership Rewards points for a statement credit towards an Eligible Purchase charged to an Eligible Card. You must redeem a minimum of 1,000 points per redemption. Redemption rates may vary by Eligible Card. Statement credits on your Card Account should not exceed the aggregate amount of the Eligible Purchase(s) on your Eligible Card. You can register for online services to view your Eligible Purchases and to redeem online. Only Eligible Purchases posted to your Card Account during the last 3 months, up to 150 most recent Eligible Purchases, will be displayed for redemption. If you wish to redeem points towards an Eligible Purchase within the last 12 months that is not displayed online, please contact us at the number listed on the back of your Card. All Eligible Purchases: 1,000 points = $10 statement credit.
For full Membership Rewards Program Terms and Conditions, visit membershiprewards.ca or call 1-800-668-AMEX (2639). Small Business Cardmembers, may call 1-888-721-1046. TM, ®: Used by Amex Bank of Canada under license from American Express.