As a business owner, gazing over at the profit number on your income statement is always a nerve-wracking moment. Though your profit may look good, you may be surprised to find that the cash account on the same balance sheet isn’t an identical number. In fact, it’s probably lower. However, these instances aren’t uncommon, especially for small businesses. To get a better grasp of where your cash has gone, it’s important to understand the relationship between your profit and cash flow and how each of these is calculated. 

What is Profit?

Your profit is equal to the amount of revenue you make minus the expenses associated with the process of earning that income. This indicates whether or not your company is still sustainable. 

What is Cash Flow?

Cash flow, on the other hand, has nothing to do with your revenue. Instead, it measures your ability to pay bills and your team. To calculate it, subtract the cash paid out during a certain period from the cash received during the same period. If your cash on hand results in a negative amount, it means that you’re spending more cash than you’re bringing in. 

What is the Difference Between Profit and Cash Flow?

Take a look at this calculation. 

Profit = revenue ($10,000) – expenses ($5,000) = $5000 total profit

Cash flow = cash-in ($5,000) – cash-out ($5,000) = $0 total cash flow

The occurrence of a positive profit number but low or negative cash flow is often an accounting issue. Sometimes, expenses aren’t recorded on the income sheet or the period of calculation for both amounts doesn’t align. 

These financial statements are calculated using accrual basis accounting, which means expenses are only reported when all goods and services are completely consumed, regardless of when your bill was paid. 

Similarly, revenues are only reported when products and services have been successfully delivered to a customer and the company can receive a cash payment, regardless of when the customer actually pays you. 

Should You Use Cash Basis Accounting?

Cash basis accounting refers to the tracking of cash within a business to calculate a net income number and more accurately reflect a business’ cash in the bank. Though this method may seem more reliable, it doesn’t reflect a company’s true profit of the month. Standard accounting practices that match expenses with their associated revenues during a reporting period is far more definitive. 

Why Cash Flow Changes

Remember that your business is receiving cash flow from three major areas: operations, investments, and financing. If you’re experiencing negative cash flow it might be due to the following reasons. 


  • Higher overhead spending


Managing a business requires investing in people, rent, tools and more. Typically, costs that aren’t directly associated with servicing a customer or producing the product is what we call overhead. You may also hear the term “Selling, General & Administrative Expenses (SG&A)”. If your cash flow is negative, you may want to check to see if you’ve over-hired, spent too much on unnecessary tools and more.


  • Offering customers credit


Although offering credit is a great way to increase sales, cash isn’t immediately added to your bank account. Instead, credit shows up on your income statement but only reflects a customer’s legal obligation to pay for the purchase they made. 


  • Making other investments


Over time, you’ll likely start purchasing equipment, tools, and other long-term assets to account for the expansion (i.e. growth) of your business. Though this expense won’t be recorded in a single period, accounting services will expense the asset gradually through depreciation. 


  • Repaying loans


Similar to personal credit card and student debts, businesses incur debt as well. You will notice cash flow decreasing as your business pays down its loans. Ensure your business has the capacity to pay off its debt or it could signal trouble for the business.

Final Thoughts

For an accurate representation of your cash flow, it’s important to take a closer look at changes in your balance sheets. You might spot “missing” cash in hidden assets such as inventory, fixed assets, or insurance. 

For personalized bookkeeping services in Boston, MA, that take the headache out of numbers and taxes, feel free to schedule a free call to learn more about how we can help you grow and manage all your accounting needs.