Profit and cash flow are two very important metrics for understanding your eCommerce business’s financial situation. Although it is not uncommon for the two terms to be confused, profit and cash flow provide two very different views of your finances. It is possible for a business to show a positive, healthy cash flow but be producing a loss, and visa versa.
Understanding the difference between profit and cash flow is vitally important for making informed business decisions. Although you may have fewer large overheads, such as retail space rent, to pay as an eCommerce business, poor cash flow and profit understanding can still just as easily land your company in hot water.
Cash flow refers to the money that comes into and out of your business over a given period of time, most commonly calculated on a monthly basis. Cash flow can be calculated, in its simplest form, by subtracting monthly cash expenditures from monthly cash income. Because of this, cash flow can be positive or negative, depending on the amount of money flowing into and out of the business.
Positive cash flow indicates that your business is operating with surplus cash, meaning that you can cover all of your expenses for that period of time, and still have cash left over from your income. With a positive cash flow, you can reinvest in your eCommerce business, upgrade your marketing campaigns, optimize your website and expand your product offerings.
Negative cash flow is the inverse. While negative cash flow does not mean that a business is failing, prolonged periods of negative cash flow can present financial risks to businesses if it leaves them unable to pay bills, suppliers or restock products.
Maintaining a positive cash flow and taking steps to prepare for periods of negative cash flow can be crucial to the survival of your eCommerce business.
When looking into your business’ cash flow, it is also important to understand the different types of cash flow. The term ‘cash flow’ is interchangeable with the term ‘net cash flow’. Net cash flow is the sum of the total cash incoming into a business, minus the total cash outflows in the form of expenses, like the definition given for cash flow above.
Free cash flow is a slightly different metric that often appears in cash flow forecasting and statements. Free cash flow is primarily used to find out the value of a business, most commonly used for investors. Unlike profit, free cash flow excludes non-cash expenses, such as depreciation and stock compensation which are included in the calculation of profit and loss.
Profit is the financial gain from the amount of money remaining from revenue after subtracting all other expenses. Like with cash flow, profit can also be positive or negative. A positive figure indicates a profit, with income greater than expenses, and a negative figure is a loss, occurring when expenses are greater than income. If your business costs are equal to your income, then you have broken even, experiencing neither a profit nor a loss. Profit is also often referred to as ‘net income’.
Profit can be calculated across all business operations: Profit = Income - Expenses.
Or for single products or activities: Profit = Unit Price - Unit Costs.
Profit is vitally important for eCommerce businesses, particularly smaller ones. Earning a profit can allow a company to secure bank loans, attract investors, and reinvest in their business to fund growth and expansion. Experiencing a loss however, can be fatal to the survival of a business, and can leave a business unable to pay expenses or generate enough revenue to keep normal operations afloat.
Much like cash flow, profit can be broken down into different types. When talking about profit, most often we are speaking about ‘gross profit’. Gross profit is the profit that you make after you subtract the costs directly associated with creating your goods or services from the revenue you generate from sales. Net profit is another type of profit, giving a wider view of your finances. Net profit is calculated by deducting all costs to your company, such as operating expenses, wages, and tax, from your total revenue.
Profit and cash flow are fundamentally different financial metrics. Each measuring business income and expenses in different ways and under different time frames. Profit indicates all the money left over whereas cash flow gives a snapshot of money flowing into and out of your business. Profit can be used to demonstrate the success or failure of your business, while cash flow can determine your financial outlook for the near future.
Profit and cash flow are also presented in different financial statements. Profit is calculated and broken down in a business’s Profit and Loss Statement, while cash flow is calculated in a Cash Flow Statement or Cash Flow Forecast for future financial periods.
As mentioned above, profit does not equate to a positive cash flow. Because of this, there are some specific circumstances where you may find one metric more useful over another, although it is always important to consider the wider picture and take into consideration both metrics when making decisions.
For example, cash flow would be a more useful metric for your business if you are in a situation where a buyer has asked you to purchase their order on credit. To determine whether you are able to offer them an order on credit, you would turn to your cash flow statement to see if you are still able to cover your upcoming expenses without receiving income from this order. In this situation, your profit would not be affected as you will still be receiving the income from your sale.
If you were launching a new product, and were trying to decide how to price your item, profit would be a more useful metric. To work out how much to charge, you would calculate the cost of producing that item, and take it away from your proposed price. This allows you to see how much money you would make from this new product and ensure that it is enough to cover the cost of production.
Profit and cash flow do interact with each other. For example, you may decide to launch an initiative to increase average order value to help you navigate a challenging cash flow period. If successful, this could not only help improve your cash flow by increasing income in the short-term, but you may see a wider increase in average order value that spans longer than the campaign period, boosting your income in the longer term and therefore your profit.
As they are so different and offer different insight into a business’s financial performance, it is hard to determine which is universally more useful over the other. Both are crucial to the financial performance of your business, and should be taken into account equally when looking at the viability of new investments or business opportunities.
Profit and cash flow offer such different insights into a business’s financial performance, making it hard to determine which is universally more useful over the other. Both are crucial to the financial performance of your business, and should be taken into account equally when looking at the viability of new investments or business opportunities.
Understanding the difference between these two metrics can allow for more effective management of your finances on a monthly basis and more long term.
If you are new to cash flow management and are looking for more information about how to calculate, forecast and manage your cash flow, download our other Cash Flow eBook chapters, or get in touch with us today.