Profit vs Cash

Learn more about the two key finance terms

What is Profit vs Cash?

Understanding the difference between profit vs cash is very important in the finance industry. Profit is defined as revenue less all the expenses of a company in a certain period, while cash flow is cash that flows in and out to/from a business throughout a certain period of time.

 

Profit vs Cash

 

Profit is a major indicator of overall business success, whereas cash is needed to keep and operate the business on a daily basis successfully. It is important to mention that, over the long term, a lack of profit exerts a negative impact on the cash flow of the company.

 

 

Quick Summary

  • After all, we can conclude that cash is not profit and profit is not cash.
  • A company can be profitable but lack adequate cash flow.
  • To succeed in business, one needs both profits and cash flow.

 

Practical Example

Imagine a situation when a director meets the accounting team to review a company’s tax payments and, generally, its financial situation at the end of the fiscal year. It turns out that the company made a significant profit compared to the previous year’s results. The accounting team also reported to the director that there was a shortage of cash in the company’s bank accounts and, therefore, it was not able to pay income tax on the profit.

To conclude the example above, businesses generate profit while being cash-negative, when others generate a lot of cash flow, but stay unprofitable. Companies need cash all the time, and they can survive with it even if they lack profit.

It goes without saying that profit is absolutely viable for a business to grow. If there is no profit over the long term, a publicly listed company will see a decline in its share price, which will make potential investors fearful of considering an investment in the company. Cash is also a necessary tool for a company’s short-term survival.

 

What Is Profit?

Profit, also called net income, is a key metric that determines a company’s success. It represents the remaining amount after deducting all the costs needed to be incurred to generate revenue. For example, if your monthly income is $15,000 and it costs your business $10,000 to generate that $15,000, then your profit is equal to $15,000 – $10,000 = $5,000.

There are two types of profit:

 

1. Gross Profit

Gross profit is a profit made after subtracting the Cost of Goods Sold (COGS) or the costs directly attributable to the manufacturing of the product or rendering a service. The formula is very simple:

 

Gross Profit = Revenue (Sales) – COGS

 

2. Net Profit

Net profit serves as a more accurate reflection of a company’s profitability compared to the gross profit because it accounts for any liabilities beyond COGS, such as sales, general & administrative (SG&A) costs, research and development (R&D) costs, interest expense, and tax payments.

The exact formula for net profit is as follows:

 

Net Profit = Revenue – COGS – Operating Expenses – Interest Expense – Taxes

 

Where:

  • Revenue – The total volume of product sales
  • COGS – Costs to manufacture the sold goods
  • Operating Expenses – Employee costs, administrative costs, research and development (R&D) costs
  • Interest Expense – Debt service or interest payments on the outstanding debt
  • Taxes – Federal, state, local income, and payroll taxes

 

What Is Cash Flow?

Cash flow represents the total amount of money that flows in and out to/from an enterprise during a certain time period. It is a good metric to identify the company’s short-term and long-term outlook.

Cash flow can be either positive or negative. Cash flow is positive when the company receives more funds than it sends out as payments, and negative when it pays more cash than it receives.

 

Types of Cash Flow

All cash flow types appear on a company’s cash flow statement. The three types of cash flows are as follows:

 

1. Cash Flow from Operating Activities

Cash flow from operating activities represents cash flow being generated by performing core business activities over a period of time. Operating activities include revenue generation, paying off costs, and funding working capital.

 

2. Cash Flow from Investing Activities

Cash flow from investing activities is cash flow coming in and out to/from a company from investments made during a specific time period.

Investing activities can include long-term asset investments, such as property, plant, and equipment (PP&E), business acquisitions (buyouts), etc.

 

3. Cash Flow from Financing Activities

Cash flow from financing activities is the cash flow generated from equity or debt issuance and repayment, dividend payments, share repurchases, etc., which are recognized as financing activities.

 

More Resources

Thank you for reading CFI’s guide on Profit vs Cash. CFI offers the Financial Modeling & Valuation Analyst (FMVA)™ certification program for those looking to take their careers to the next level.

To keep learning and advancing your career, the following resources will be helpful:

  • Flow of Funds Indicators
  • Projecting Income Statement Line Items
  • Statement of Cash Flows
  • Taxable Income

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