Cash flow versus profit: Why being profitable isn’t the whole picture

Starting a thriving business and having it finally becoming profitable is an incredible milestone for founders. But, even with a strong profit and loss (P&L) statement and a positive net income, you could still be constantly stressed about cash. Perhaps you have vendors waiting for payments, and the scheduled payroll feels tight. That’s because seeing profits and having steady cash flow aren’t the same thing.

It’s common for early-stage startups to get cash flow vs. profit mixed up. The key difference is that profit is an accounting measure, whereas cash flow is about the viability of day-to-day financial operations. 

To help you understand why profitability isn’t the main indicator of financial success, we’ll guide you through the differences between profit vs. cash flow and how to interpret cash flow metrics. Plus, we’ve included a go-to founder’s checklist to help you make sound operating and fundraising decisions. 

Regardless of whether you’re running a pre-seed company or you’ve secured Series B funding, it’s important to recognize the difference between profit vs. cash flow. Knowing these terms will help you communicate clearly with investors, analysts, and other stakeholders. So, to clear up any confusion, let’s review the differences between cash flow vs. profit..

Profit

Profit is the amount of revenue after deducting expenses, reported on the income statement. It adheres to the accounting principles. Revenue is recorded when it’s earned, not when cash is received. In theory, you could have strong profits on paper. But, in reality, you may have trouble paying your bills if you don’t have adequate cash flow.

Cash flow

Cash flow is the movement of money coming in and out of a business. It can be a positive or negative number. The totals in your company’s bank account is a telltale sign of whether you’re in a good financial position to cover your payroll and suppliers.

Example scenario: A subscription company

Let’s say your company sold a $60,000 annual subscription service, and the customer paid in full upfront. You would recognize $5,000 in revenue per month ($60,000 divided by 12 months). However, you’ll also need to pay $6,000 in monthly expenses. 

The takeaway: On your income statement, your company will appear to be profitable over these 12 months. Although if your expenses are greater than the inflow of cash in any particular month, you’ll be cash flow negative. That means that you’ll have more money leaving your business than coming in. 

Making a profit is a key indicator of an entrepreneur's success, and it’s an achievement worth celebrating when your team has been putting in a lot of sweat equity. However, instead of feeling elated, founders can easily fall into the trap of being strapped for cash. Why does this happen? 

Well, startups usually invest significant financial resources from day one. They’re juggling all aspects of their business, including covering upfront costs, purchasing inventory, and paying off their loans. On top of that, they’re dealing with the timing of their deferred revenue or facing delays in their accounts receivable. All this to say, it’s easy to burn through tons of cash to grow your business.

How timing gaps create cash problems

Say you closed a deal with a major client (high five!). However, they may not pay you for 60 days. In the meantime, you’ll still need to pay your employees and keep the lights on. 

On paper, you’re in the black (you’re profitable), but your bank balance may be bleeding cash. That’s where timing differences can put financial strain on early-stage startups.

Just because your company is cash flow positive doesn’t mean that it’s profitable. Let’s examine two classic scenarios.

Scenario #1: Profitable, but cash flow negative

An e-commerce startup secures a $275,000 annual contract, with the revenue recognized monthly. The client has 90 days to pay. Meanwhile, the founder still needs to cover office rent, payroll, marketing expenses, and supplier payments. Although the company is profitable, cash is going out faster than it’s coming in.

Scenario #2: Cash flow positive, but not profitable

A customer relationship management (CRM) company successfully raised a $2M seed round. The cash flow statement displays positive cash flow from the financing received. However, operational expenses cost $200,000 per month. The founder sees a net loss on their income statement, even though their cash balance increased due to investor funding. 

The takeaway: Overall, if you look at the income statement, the first scenario  would appear favorable. Whereas, if you review only the cash balance, the second scenario would look solid. In reality, founders need both sustainable profits and positive cash flow to succeed. 

Two more important terms founders should be able to distinguish and clearly understand are net cash flow vs. net profit. 

Net cash flow 

Net cash flow is shown on your cash flow statement. It reflects the difference between cash inflows and cash outflows over a specific period. The types of cash flow include the company's operating, financing, and investing transactions. 

Net profit

Net profit is the bottom line listed in your P&L statement. Also known as net income, it’s the revenue minus all your expenses. For example, expenses include your cost of goods sold (COGS), operating expenses, interest expenses, and taxes.

Net profit factors in depreciation and amortization, which, in turn, decreases the profit. Shifts in working capital — such as increasing inventory and growing accounts receivable — may reduce cash. Hence, profitable businesses can still face cash shortages. 

Before you head into a meeting with financial decision makers, you may want to brush up on the definitions of operating cash flow vs. operating profit. Here’s a quick overview of what these terms mean. 

Operating profit

Operating profit represents the earnings from core business activities after operating expenses (such as salaries, utilities, and rent). It’s commonly referred to as EBIT, which stands for the earnings before interest and taxes. It demonstrates whether a company’s operations are feasible. 

Operating cash flow

Operating cash flow is the cash generated from daily operations, excluding financing and investment expenses. It indicates if your business is generating enough cash from products or services to cover its costs. 

Example scenario: A wellness startup

A startup specializing in wellness products increases its revenue by 25% year over year. The operating profit increases because sales exceed operating expenses. However, customers have 60 days to pay, so the accounts receivable start to grow. The revenue is earned, but the cash hasn’t arrived yet. Meanwhile, the company decides to build up inventory ahead of peak demand. The operating profit increases, but the operating cash flow decreases. 

The takeaway: Based on this scenario, founders should track both the operating cash flow and operating profit metrics.

In an ideal world, it’d be convenient to have a single metric to assess a company’s financial well-being. In practice, leveraging both the cash flow and profit metrics can empower business owners to make informed decisions, attract potential investors, and secure loans. The data you’ll want to focus on depends on the stage of your business. 

Early-stage or high-growth startups

Early-stage or high-growth startups should zero in on cash flow and runway metrics. Ideally, you’ll want to aim for 12 to 24 months of runway to build a cash buffer and some breathing room. Venture capitalists and investors want to see whether your company can handle financial turbulence. 

Established companies 

To ensure the business model is sustainable in the long run, mature and established companies with a proven track record need to shift their focus to profitability and stable operating cash flow,.

Remember, you can’t scale what you can’t fund. If you want to grow your business, you’ll need to have sufficient operating cash flow and a strategic plan to use your working capital wisely. Having clear data insights — such as understanding your cash flow, runway, and profitability — will give you financial visibility that you can use to make informed business decisions. 

To help you better manage your organization’s cash flow, here’s a checklist you can use to distinguish between cash flow vs. profit: 

• Are receivables growing faster than revenue? If so, this may indicate that some of your profit is tied up in unpaid invoices, which can jeopardize your cash flow. 
• Are you funding growth with payables? If so, this could be a sign that you’re delaying vendor payments to finance your operations. 
• How many months of runway do you have based on actual cash? If you don’t have at least 12 months of runway, a cash shortage could lead to layoffs or budget cuts.
• Are you profitable but cash flow negative? Why? If you see your bank balance shrinking, it could be because there are delays in customer payments, you have major investments in capital expenditures, or you have excess inventory. 

Go through this checklist monthly to gauge if your business is on the right track or if you need to make adjustments. Sticking to this habit will require some discipline. Once you get into the groove, though, it’ll become a natural part of your routine. 

Becoming profitable is an outstanding achievement. But keep in mind that cash flow also supports a company's daily operations. Although a company can be profitable, as a founder, you must ensure steady, healthy cash flow. Maintaining a positive cash flow makes it easier to pay your employees, vendors, and bills on time. Achieving this will relieve the pressure of keeping your company afloat. 

Now that you understand how both cash flow and profit can work hand-in-hand, these figures can help you forecast and make strategic decisions to drive your company's growth. 

You can stay on top of your cash flow by viewing your transactions in one place. Learn how Mercury can help you balance your profit and cash flow.