The Relationship Between Investment, Profit, and Cash Flow
- Your pizza shop received a huge boost on social media and you've been experiencing a surge in customers and business.
- To accommodate this new demand, you decide to invest in a new oven, expecting it to boost production and profits.
- However, this purchase drains your cash reserves, leaving you struggling to pay suppliers.
- This scenario highlights how investment, profit, and cash flow—three critical elements of financial management link.
Investment: Short-Term Outflows for Long-Term Gains
Definition
Investment
The purchase of non-current assets (e.g., machinery, property) or financial assets (e.g., stocks, bonds) with the expectation of generating future returns.
How Investment Affects Cash Flow
- Immediate Cash Outflows: Investments often require significant upfront spending, reducing available cash.
- Delayed Returns: The benefits of an investment, such as increased revenue or cost savings, may take time to materialize.
- Financing Options: Businesses may use loans or equity to fund investments, spreading cash outflows over time through repayments or dividends.
Amazon's investment in a wind farm could lower energy costs and attract eco-conscious customers, but operational delays might postpone profit increases.
Profit: The Measure of Financial Success
Definition
Profit
The financial gain obtained when revenue exceeds expenses, can be classified as gross profit, operating profit, or net profit.
Why Profit Doesn't Equal Cash Flow
- Non-Cash Expenses: Depreciation and amortization reduce profit but don't affect cash flow.
