What Does a Positive Cash Flow Mean

What Does a Positive Cash Flow Mean

Cash flow and profit are both important financial metrics in business, and it isn't uncommon for those new to the world of finance and accounting to occasionally confuse the two terms. But cash flow and profit are not the same things, and it's critical to understand the difference between them to make key decisions regarding a business's performance and financial health.

For investors, understanding the difference between profit and cash flow can make it easier to know whether a profitable company is actually a good investment based on its ability to remain solvent in times of economic crisis. For entrepreneurs and business owners, understanding the relationship between the terms can inform important business decisions, including the best way to pursue growth.

Here's everything you need to know about cash flow, profit, and the difference between the two concepts.

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What is Cash Flow?

Cash is constantly moving into and out of a business. When a retailer purchases inventory, for example, money flows out of the business toward its suppliers. When that same retailer sells something from inventory, cash flows into the business from its customers. When the retailer pays its workers or utility bills, cash flows out of the business, toward its debtors. When the retailer collects a monthly installment on a purchase that a customer financed 18 months ago, cash flows into the business. The list goes on.

Cash flow refers to the net balance of cash moving into and out of a business at a specific point in time.

Cash flow can be positive or negative. Positive cash flow indicates that a company has more money moving into it than out of it. Negative cash flow indicates that a company has more money moving out of it than into it.

Cash flow can be further broken into three major categories:

• Operating cash flow: This refers to the net cash generated from a company's normal business operations. In actively growing and expanding companies, positive cash flow is required to maintain business growth.
• Investing cash flow: This refers to the net cash generated from a company's investment-related activities, such as investments in securities, the purchase of physical assets like equipment or property, or the sale of assets. In healthy companies that are actively investing in their businesses, this number will often be in the negative.
• Financing cash flow: This refers specifically to how cash moves between a company and its investors, owners, or creditors. It's the net cash generated to finance the company and may include debt, equity, and dividend payments.

Related: Financial Terminology: 20 Financial Terms to Know

The Cash Flow Statement

Cash flow is typically reported in the cash flow statement, a financial document designed to provide a detailed analysis of what happened to a business's cash during a specified period of time. The document shows the different areas in which a company used or received cash and reconciles the beginning and ending cash balances.

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What Is Profit?

Profit is typically defined as the balance that remains when all of a business's operating expenses are subtracted from its revenues. It's what's left when the books are balanced and expenses are subtracted from proceeds.

Profit can either be distributed to the owners and shareholders of the company, often in the form of dividend payments, or reinvested back into the company. Profits might, for example, be used to purchase new inventory for a business to sell, or used to finance research and development (R&D) of new products or services.

Like cash flow, profit can be depicted as a positive or negative number. When this calculation results in a negative number, it's typically referred to as a loss, because the company spent more money operating than it was able to recoup from those operations.

Like cash flow, profit can be further broken down into three categories:

• Gross profit: Gross profit is defined as revenue minus the cost of goods sold. It includes variable costs, which are dependent upon the level of output, such as cost of materials and labor directly associated with producing the product. It doesn't include other fixed costs, which a company must pay regardless of output, such as rent and the salary of individuals not involved in producing a product.
• Operating profit: Like operating cash flow, operating profit refers only to the net profit that a company generates from its normal business operations. It typically excludes negative cash flows like tax payments or interest payments on debt. Similarly, it excludes positive cash flows from areas outside of the core business. It's sometimes referred to as earnings before interest and tax (EBIT).
• Net profit: This is the net income after all expenses have been deducted from all revenues. Typically, this includes expenses like tax and interest payments.

The Income Statement

Information about a company's profits is typically communicated in its income statement, also known as a profit and loss statement (P&L). This statement summarizes the cumulative impact of revenue, gains, expenses, and losses over the course of a specified period of time.

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The Difference Between Cash Flow and Profit

The key difference between cash flow and profit is that while profit indicates the amount of money left over after all expenses have been paid, cash flow indicates the net flow of cash into and out of a business.

Which Is More Important: Cash Flow or Profit?

Investors and business owners are often in search of a single metric by which they can understand the health of a company. They want to know the one number they should look at to determine whether they should make an investment, or pivot their business strategy. Cash flow and profit, as two critical and related financial metrics, often get pitted against each other: Which is more important?

There isn't a simple answer to that question; both profit and cash flow are important in their own ways. As an investor, business owner, key employee, or entrepreneur, you need to understand both metrics and how they interact with each other if you want to evaluate the financial health of a business.

For example, it's possible for a company to be both profitable and have a negative cash flow hindering its ability to pay its expenses, expand, and grow. Similarly, it's possible for a company with positive cash flow and increasing sales to fail to make a profit, as is the case with many startups and scaling businesses.

Profit and cash flow are just two of the dozens of financial terms, metrics, and ratios that you should familiarize yourself with to make informed decisions about a business. By gaining a thorough understanding of key financial principles, it's possible to advance professionally and become a smarter investor or business owner.

Are you interested in gaining a toolkit for making smart financial decisions and the confidence to clearly communicate those decisions to key stakeholders? Explore our online finance and accounting courses and discover how you can unlock critical insights into your organization's performance and potential.

Data Tables

Company A - Statement of Cash Flows (Alternative Version)

Year Ended September 28, 2019 (In millions)

Cash and cash equivalents, beginning of the year: $10,746

OPERATING ACTIVITIES

Activity	Amount
Net Income	37,037
Adjustments to Reconcile Net Income to Cash Generated by Operating Activities:
Depreciation and Amortization	6,757
Deferred Income Tax Expense	1,141
Other	2,253
Changes in Operating Assets and Liabilities:
Accounts Receivable, Net	(2,172)
Inventories	(973)
Vendor Non-Trade Receivables	223
Other Current and Non-Current Assets	1,080
Accounts Payable	2,340
Deferred Revenue	1,459
Other Current and Non-Current Liabilities	4,521
Cash Generated by Operating Activities	53,666

INVESTING ACTIVITIES

Activity	Amount
Purchases of Marketable Securities	(148,489)
Proceeds from Maturities of Marketable Securities	20,317
Proceeds from Sales of Marketable Securities	104,130
Payments Made in Connection with Business Acquisitions, Net of Cash Acquired	(496)
Payments for Acquisition of Intangible Assets	(911)
Other	(160)
Cash Used in Investing Activities	(33,774)

FINANCING ACTIVITIES

Activity	Amount
Dividends and Dividend Equivalent Rights Paid	(10,564)
Repurchase of Common Stock	(22,860)
Proceeds from Issuance of Long-Term Debt, Net	16,896
Other	149
Cash Used in Financing Activities	(16,379)

Increase / Decrease in Cash and Cash Equivalents: 3,513

Cash and Cash Equivalents, End of Year: $14,259

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Company B - Annual Trial Balance (Alternative Version)

September 28, 2019 (In thousands)

Accounts	Debit	Credit
Cash and cash equivalents	260,652
Accounts receivable	467,976
Inventory	676,089
Other current assets	116,775
Property, plant & equipment	985,563
Long-term intangible assets	1,223,400
Other long-term assets	31,093
Current portion of long-term debt		14,689
Accounts payable		312,170
Accrued expenses		242,427
Other current liabilities		27,777
Long-term debt, less current portion		236,282
Other long-term liabilities		281,588
Common stock		1,392,183
Retained earnings		771,200
Net Sales		4,358,100
Cost of Sales	2,738,714
Selling and operating expenses	560,430
General and administrative expenses	293,729
Other income		960
Gain or loss on financial instruments, net		5,513
Gain or loss on foreign currency, net	12,649
Interest expense	18,177
Income tax expense	257,642
Total	7,642,889	7,642,889

Company B Income Statement

For Year Ended September 28, 2019 (In thousands)

Activity	Amount
Net Sales	4,358,100
Cost of Sales	2,738,714
Gross Profit	1,619,386
Selling and Operating Expenses	560,430
General and Administrative Expenses	293,729
Total Operating Expenses	854,159
Operating Income	765,227
Other Income	960
Gain (Loss) on Financial Instruments	5,513
(Loss) Gain on Foreign Currency	(12,649)
Interest Expense	(18,177)
Income Before Taxes	740,874
Income Tax Expense	257,642
Net Income	483,232

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About the Author

Tim Stobierski is a marketing specialist and contributing writer for Harvard Business School Online.

Source: https://online.hbs.edu/blog/post/cash-flow-vs-profit

Posted by: newlingwromem.blogspot.com

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