Differentiating Profit and Cash Flow
- A business can be profitable but still run out of cash.
- While profit measures how much money remains after covering costs, cash flow determines whether a business can pay its bills on time.
- Many businesses fail not because they are unprofitable, but because they lack cash when they need it.
Definition
Profit
The financial gain obtained when revenue exceeds expenses, can be classified as gross profit, operating profit, or net profit.
Definition
Cash Flow
The movement of money into and out of a business over a specific period. It includes both cash inflows (receipts) and cash outflows (payments).
Why a Profitable Business May Lack Cash
A business can generate profit but still struggle with liquidity due to the timing of cash inflows and outflows.
1. Delayed Customer Payments
- Many businesses sell goods on credit, meaning customers take 30, 60, or 90 days to pay.
- This creates a gap where the business must cover expenses (e.g., rent, wages, supplier payments) before receiving cash.
2. High Stock Levels
- Businesses that hold large amounts of inventory (e.g., jewelers, car dealerships) have significant cash tied up in stock.
- Until those items are sold, the cash is not available for daily operations.
3. Investment in Non-Current Assets
- Purchasing equipment, machinery, or property requires large cash outflows upfront, even though these assets generate revenue in the long run.
- This can cause short-term cash shortages despite long-term profitability.
- A construction firm purchases expensive machinery, reducing its immediate cash reserves.
- Although profitable, it struggles to cover short-term expenses like wages and material costs.
