PROFIT VS CASH FLOW
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I regularly have discussions with clients about the difference between "profit" and "cash flow", as many people have difficulty in differentiating between the two.
So what is the difference between profit and cash flow? Frequently it's the difference between success and bankruptcy.
Profit
Profit is the surplus remaining after total expenses are deducted from total income. Expenses include explicit costs of doing business, such as depreciation, interest and taxes (not GST). Income is calculated at the time the sale is booked, rather than when full payment is received. Likewise, expenses are calculated at the time the purchase is made, rather than when you pay the bill.
Cash Flow
Cash flow is the difference between inflows (actual incoming cash) and outflows (actual outgoing cash). Income is not counted until payment is received and expenses are not calculated until payment is made. Cash flow also includes the introduction of working capital from investors or debt financing.
Cash comes in from customers who are buying your produces or services, or, say, from the sale of fixed assets, GST refunds or owners introducing funds. If a customer does not pay at the time of purchase, then some of your cash flow will come from accounts receivable. On the other hand, cash goes out of your business in the form of payments for expenses, like rent or interest, repayments of principal on loans, purchase of assets, payment of taxes/GST and accounts payable.
Cash Flow and Profit Don't Always Match
Say you are in the business of investing in residential rental property and you make income from rents collected. The business can be profitable, as the rental income covers interest, rates, insurance etc, but the business can still go bankrupt from cash flow problems.
You must pay the interest on the mortgage each month, or the rates every 3 months, but what happens if your tenant does not pay their rent to you for 2 or 3 months? Then you will need to get finance from another source to survive until the rent is paid. If you don’t get that alternative finance and the mortgage is not paid, then the bank could force you out of business.
Summary
Profit is the surplus remaining after total expenses are deducted from total income. Cash flow is when you actually get and pay the cash. In the long term, you must get profitable or find another source of funds, i.e. private means, to keep giving you cash to make up for your losses. In the short term, even if you’re profitable, you survive or fail based on whether you have cash to pay the bills. That’s why they say "Cash Flow or Cash is King".
Profit
Profit is the surplus remaining after total expenses are deducted from total income. Expenses include explicit costs of doing business, such as depreciation, interest and taxes (not GST). Income is calculated at the time the sale is booked, rather than when full payment is received. Likewise, expenses are calculated at the time the purchase is made, rather than when you pay the bill.
Cash Flow
Cash flow is the difference between inflows (actual incoming cash) and outflows (actual outgoing cash). Income is not counted until payment is received and expenses are not calculated until payment is made. Cash flow also includes the introduction of working capital from investors or debt financing.
Cash comes in from customers who are buying your produces or services, or, say, from the sale of fixed assets, GST refunds or owners introducing funds. If a customer does not pay at the time of purchase, then some of your cash flow will come from accounts receivable. On the other hand, cash goes out of your business in the form of payments for expenses, like rent or interest, repayments of principal on loans, purchase of assets, payment of taxes/GST and accounts payable.
Cash Flow and Profit Don't Always Match
Say you are in the business of investing in residential rental property and you make income from rents collected. The business can be profitable, as the rental income covers interest, rates, insurance etc, but the business can still go bankrupt from cash flow problems.
You must pay the interest on the mortgage each month, or the rates every 3 months, but what happens if your tenant does not pay their rent to you for 2 or 3 months? Then you will need to get finance from another source to survive until the rent is paid. If you don’t get that alternative finance and the mortgage is not paid, then the bank could force you out of business.
Summary
Profit is the surplus remaining after total expenses are deducted from total income. Cash flow is when you actually get and pay the cash. In the long term, you must get profitable or find another source of funds, i.e. private means, to keep giving you cash to make up for your losses. In the short term, even if you’re profitable, you survive or fail based on whether you have cash to pay the bills. That’s why they say "Cash Flow or Cash is King".
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Hi Salesh, I just wanted to send you an email on behalf of GRA to say how fantastic we have found your company to date. As you know, Ben and I joined GRA a couple of months ago and have just found you so amazingly helpful in getting our new property set up correctly and sorted out. We have what I would consider a rather complicated structure as a result and it’s a fantastic feeling to know that we are getting everything done in the best way possible. We have just had approval to put a minor dwelling on the property which will make a massive difference in terms of cash flow and obviously value, something we would never have even thought of without GRA and which we are very excited about. During the buying process we attended a seminar with Matthew and from the outset thought he was fab. We therein signed up for property school and found this nothing short of fantastic. The content was relevant, up to date and comprehensive, but more importantly it was taught in a way that we could actually understand and really get value out of. I wanted to mention also, that everybody GRA have recommended to us has been just so efficient and absolute masters at what they do. A wonderful network of people that we feel very lucky to now be able to call on. From Kris Pederson and Bryan Rist who put our mortgage together to the insurance guys they then referred us to, I’m super impressed. Within GRA, Ellery has probably turned things around for us faster than I’ve ever known before, something which we appreciated so very much when it came to crunch time. She’s always a pleasure to deal with and again, we’re stoked. We’ve just settled on the property today and are about to go and get the keys. I’m pretty pumped and hence this email is probably rather excitable. So, a massive thank you to you Salesh, the partners for such a fabulous 6 weeks at property school and everyone at GRA for their help. May this be the start of our property empire. Thanks again, - A & B - July 2015
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