5 min read

Profit vs. Cash Flow: how true is the adage ‘Revenue is Vanity, Profit is Sanity, but Cash is King?

“Revenue is vanity, profit is sanity, but cash is king. This is a proverb that resonates through the corridors of startups and multinationals alike in the fast-paced world of business, where every penny counts and every choice can change the course of success. This popular proverb distills the essence of financial wisdom and acts as a beacon of guidance for business leaders and entrepreneurs navigating the treacherous waters of financial management.

But what’s really behind this catchy phrase? 

Fundamentally, it emphasizes how crucial it is to comprehend the gap between profit and cash flow, as this may make or break a company. Although profit, which is sometimes seen as the measure of success, provides information about a company’s financial health on paper. On the other side, cash flow is actually what powers daily operations and long-term expansion.

However, why does this distinction matter, and how does it shape the path to sustainable growth and stability?

So, now, let’s explore how a better understanding of profit and cash flow might revolutionize the financial strategy of your company.

The significance of distinguishing cash flow from profit

Profit may first seem to be the best measure of a company’s performance. It narrates a tale of monetary gain, with earnings exceeding costs. Even still, without taking into account cash flow—the vitality that powers daily operations, motivates investments, and ensures financial stability—this story falls short, despite its appealing nature. 

Beyond simple accounting semantics, the distinction between profit and cash flow is essential to sound financial management. Gaining an understanding of this distinction is similar to learning the art of financial balance, which guarantees that a company may prosper today while making strategic plans for the future.

What is profit?

Profit, also called net income, is the surplus or left-over, or what remains after all expenses are deducted from the sales revenue. Revenue does not mean that there will be a profit; it can be a loss too, and that is why it is called vanity. Net profit, which is essential for a business to generate cash to distribute returns to shareholders, repay loans, and reinvest to survive and grow, is the basis on which tax is computed. This will come into play in the UAE once corporate taxation kicks in post-June 2023. There are three major types of profit that companies report on their profit and loss or income statement:

  • Gross profit – the profit arrived at after deducting the costs associated with making and selling its products (cost of goods sold, COGS) or the costs associated with providing its services (cost of sales, COS)
  • Operating profit and EBITDA – total earnings from its core business functions for a given period, excluding non-operating income like interest earned and the deduction of interest and taxes. EBITDA differs in that amortization and depreciation of capital investments are deducted from operating profit, making it much closer to cash flow.
  • Net profit – the final profit after considering all income (operating and non-operating) and all expenses (operating, non-operating, and non-cash).

Each type of profit gives the readers of the profit and loss statement an insight into the company\’s performance, especially when compared to previous periods, peers, and industry benchmarks. The analysis of each type of profit guides businesses in making informed business decisions; for example, gross profit tells you how much it will cost you to make the product ready for sale and net profit gives you a view of what is left for profit distribution, how much can be reserved for future needs, and the amount that can be reinvested for diversification or expansion. That said, these are possible only if cash is available.

What is cash flow?

Cash flow is the inflow and outflow of money in a business through and out of the business cycle, in the form of a collection of invoices, paying vendors, taxes, and employee salaries, and meeting other operating costs.

 

What Is Cash Flow?

 

In other words, it excludes all accruals, provisions, and non-cash expenses like depreciation and amortization. Positive cash flow enables organizations to settle debts, reinvest in their businesses, distribute profit and return money to shareholders, and maintain a reserve against future financial contingencies. Negative cash flow indicates that a company will find it difficult to meet its liabilities in time and cannot grow the business.

There are three types of cash flow: operating, investing, or financing activities on the statement of cash flows, depending on the nature of the activities. 

  • Operating activities include cash movements related to the operating activities, like cash collected from the revenue generated and cash paid to vendors against the supply of goods and services required for the operations
  • Investing activities include cash activities related to noncurrent assets like investments in capital assets, long-term investments, loans made to other entities, and cash received  from the sale of land, but not the interest received from loans
  • Financing activities include the movement of cash related to noncurrent liabilities and owners’ equity, like the amount of long-term loan received, cash received against the sale of equity stock or cash paid to repurchase equity or repurchase of equity stock, and the payment of dividends, but not the interest paid on long-term loan

The Cash Flow Formula

The formula for calculating cash flow is straightforward yet revealing: Cash Flow = Cash from Operating Activities +(-) Cash from Investing Activities +(-) Cash from Financing Activities. 

This formula encapsulates the total picture of how cash moves through a business, highlighting the importance of not just earning revenue, but also managing investments and financing activities effectively.

 

Cash Flow Formula

 

What is the difference between cash flow and profit?

Cash flow is the actual money coming in and going out of your business; the difference between them is the cash position, positive or negative. Profit is what remains from sales revenue billed and recognized, though not collected, after meeting all the expenses incurred, though not paid. When you raise an invoice, you recognize it as revenue, subject to the provisions in the applicable accounting standard –  in accounting and report it in the profit and loss statement, but it is reported in cash flow only when the money is collected from the customer against the invoice. Likewise, when you receive goods or services from vendors, you book their invoices as expenses or inventory, but cash flow will be affected only when you pay those bills. Similarly, investments in non-current assets will appear in cash flow when they are paid, whereas only the portion of depreciation relevant for the period will come in the income statement.

 

Difference Between Cash Flow and Profit

 

A business can be profitable but still not have adequate cash flow. A business can have good cash flow and still not report a profit. For example, if a company that makes a profit invests in capital or growth projects, cash flow can get tight or negative, creating a need for external funding. Both cash flow and profit are essential for companies to stay in business and grow over the long term.

How do cash flow and profit interact?

As discussed, being profitable does not necessarily mean your cash flow is in a better position, and having positive cash flow does not mean that your business is profitable. For cash flow, cash-to-cash cycle time (also known as a cash-conversion cycle or order-to-pay cycle) that measures the days between the purchase of materials/inventory from suppliers and the collection of payment from customers is important.

If your customer delays payment of your invoices by 60 days after the credit date, you may still make a profit, but it will affect your ability to pay your suppliers, meet payroll, and pay other operational expenses, affecting your business operations. Likewise, if you make a capital investment in equipment or other assets to diversify or expand, the cash goes out initially and is reflected in the investing part of the cash flow. However, the entire upfront investment is not shown in the income statement, only the depreciation for the reporting period, based on statutory and tax provisions. 

Also read: Cash flow mistakes to avoid

Profit vs. Cash Flow: Which is more important to a business? 

The answer to that question depends on the type of business and the situation. Cash flow needs more focus to run the business. This is when a business generates profits consistently, but there is no cash to pay vendors and employees. It is because its cash is held up in receivables and other assets. If the business is neither profitable nor has a cash surplus from operating cash flow, the focus has to be on making a profit. 

Unless you make a profit, there won’t be any cash from operations; a loan fund is a liability. The absence of a profit eventually has a declining effect on cash flow. While profit is a better measurement of the success of your business, cash flow is indispensable for running the business. In the long term, the absence of profit impacts cash flow.

Business owners and leaders should have a sufficient understanding of the difference between profit and cash for better decision-making. 

However, most small businesses may not have the competence to handle the situation. This is where a SaaS application that is both accounting and finance at an affordable subscription rate, without the need to invest upfront, can help you. These tools work for you as an accountant and financial analyst or even a CFO who can give you all the financial insights that you need to manage and scale your business.

Why is cash flow more important than profit?

 

Why is Cash Flow More Important Than Profit?

 

In the world of business, profit is frequently the focus of attention, and many people associate profitability with success. But when one looks more closely at the financial nuances of managing a company, one finds a different hero: cash flow. However, why is cash flow valued higher than profit? Let’s look at several examples that highlight how crucial cash flow is compared to simple profitability.

Consider a company that, at least on paper, looks lucrative, with strong margins and significant revenue growth. Under the surface, though, it struggles to pay for salaries and other regular obligations like supplier payments. This contradiction occurs when recorded profits are linked to unpaid bills or inventory that is left on the shelf—assets that are not easily exchanged for cash to settle debts. A situation like this emphasizes the meaning of the proverb “Cash is king.”

A tech startup, for example, might land a big contract and anticipate big profits. But if the terms of payment are spread out over a number of months, and the business’s operating costs don’t change, it may struggle to maintain operations even though it is “profitable.” Businesses may find themselves in a situation known as a “liquidity trap” when they have long-term profitability but are unable to pay their short-term debts due to this disparity between profit and cash flow.

This is the point at which cash flow management becomes crucial. Having a solid understanding of and emphasis on cash flow management—made possible by cutting-edge technologies like Paci.ai—enables organizations to flourish rather than just survive, proving that cash flow is, in fact, more important than profit for a company’s long-term viability.

How does Paci.ai help with financial management?

 

How does Paci.ai now fit into this scheme of things?

 

Businesses frequently face difficult obstacles on their path to financial mastery. This includes figuring out how to interpret the minute distinctions between operational profit and cash flow or navigating the complexities of cash flow statements. Here’s where Paci.ai emerges as a cutting-edge application. Paci.ai provides a smooth solution for hassle-free financial management with a well-balanced combination of human competence and AI technology. Businesses may overcome the challenges of traditional financial management using Paci.ai, obtaining clear insights and practical tactics to improve their financial decision-making. 

In addition to being a tool, Paci.ai is a partner that helps companies understand their finances so they may concentrate on expansion without sacrificing their financial stability. When it comes to elucidating the “cash flow formula” or explaining “why cash flow is more important than profit,” Paci.ai is prepared to illuminate the route to monetary success and clarity.

 

Prompting users to try paci.ai

 

Conclusion

Through our exploration of the profit and cash flow financial landscapes, we have discovered the real meaning of the proverb “Revenue is Vanity, Profit is Sanity, but Cash is King.” 

Comprehending the distinction between profit and cash flow is not only advantageous but also crucial to the well-being and prosperity of any enterprise. Profit reveals the potential, but cash flow is what keeps the company running on a daily basis. 

Paci.ai provides a smooth solution for individuals wishing to travel through these waters with ease. Its integration of AI technology and human knowledge makes efficient financial management more than just a dream. 

Reach out to us today and take the first step towards financial clarity and peace of mind.

Subscribe to receive exclusive offers and news

Get the best, coolest, and latest in the financial world, delivered to your inbox each week.

Related articles

Basics of Bookkeeping for Small Business

Did you know that the profitability of small businesses might rise by as much as 20% due to good bookkeeping? It involves more than just...

5 Steps for Corporate Tax Registration UAE

Are you trying to find an easy way around the UAE corporate tax registration landscape? Find out how easy it is to register for taxes...

Best Accounting Services in Dubai

In Dubai’s fast-paced business world, many entrepreneurs face a big question: How do you pick the right accounting services for your...

8 Benefits of Accounting Software for Enterprises

In the dynamic landscape of today’s business world, growing enterprises are continually seeking ways to streamline their operations...

8 Benefits of Using Cloud Accounting For Remote Team

Are you tired of waiting for your team to coordinate on spreadsheets, especially when everyone works from different places? Or maybe...

The Ultimate Guide to Accounting Software For CFO Teams

Ever wondered why some companies hit financial roadblocks even when they have brilliant CFOs steering the ship? The answer often lies in the...
Related articles
How To Choose Accounting Services In Dubai?

Best Accounting Services in Dubai

In Dubai’s fast-paced business world, many entrepreneurs face a big question: How do you pick the right accounting services for your...