Cash Flow vs Profit: Why Profitable Businesses Still Run Out of Money

Although both cash flow and profit are indicators of a company’s financial health, they are not mutually exclusive metrics. Indeed, oftentimes one comes across cash-rich business who are showing a loss in their profit and loss or profitable ventures who suffer from a lack of cash. To understand why this happens, one must look at what both profits and cash mean and understand how, rather than just measuring one or the other, a business can use both to ensure its success in the market both in the present and the future.

Profits are the difference between an enterprise’s revenue (or income generated) and its expenses (be they direct expenses incurred as a result of the income generated or expenses incurred due to the daily operations of the business). For illustrative purposes, business profits can summarised using the following formula:

Profit=Revenue−Direct Costs−Operating Expenses

Cash flow, on the other hand, examines the movement of cash into and out of the business. It measures the net cash generated from all activities that the business undertakes, be they operating, investing, or financing activities. In simple terms, the definition of cash flow can be illustrated using the below formula:

Cash Flow=(Investing Activities: Income−Expenses)+(Operating Activities: Income−Expenses)+(Financing Activities: Income−Expenses)

Cash flow is influenced by the following:

Debtors

A business may appear profitable on paper, yet still struggle financially if customers fail to pay invoices on time. For example, if an aged debtors report reveals a large number of overdue balances beyond the standard 30-day credit period, the business may need to strengthen its debt collection procedures. Regularly reviewing outstanding receivables and following up with customers can significantly improve liquidity.

Creditors

Some industries operate with strict supplier payment terms or even require prepayment for goods and services. If a business grants generous credit terms to customers while simultaneously paying suppliers quickly, it may create unnecessary pressure on cash reserves. Aligning customer payment terms with supplier obligations is therefore crucial for maintaining healthy liquidity.

Stock

Excessive stock ties up cash that could otherwise be used for operational needs or investment opportunities. For this reason, businesses often aim to maintain optimal inventory levels rather than excessive stockpiles. Modern inventory management systems such as “Just In Time” (JIT) have become increasingly popular, while some businesses — particularly in sectors such as furniture retail — minimise inventory altogether by shipping products directly from suppliers to customers.

Unlike profit, cash flow focuses exclusively on actual cash movements rather than expected income or expenses. This is an important distinction to make as although both profit and cash flow appear to measure financial performance, these fundamentally different approaches mean that, in reality, each of them is assessing a different area of financial performance.

Consider the example of a sale made on 30-day credit terms. Once the invoice is issued, the sale must be recorded in the profit and loss statement, even though the customer has not yet paid. At this stage, the business reports a profit because it expects to receive payment in the future. When compiling a profit and loss, the report is prepared using the accrual accounting concept, which records expected income and expenses when they are earned or incurred. This is independent of the fact that one’s sales and expenses have been paid or not. As a result, profit reflects expected earnings rather than actual cash available to the business, meaning profit is a measure of performance.

Cash flow, on the other hand, only records transactions when cash is transferred from one party to the other. Using the same example, the sale would be recorded as cash received in the statement of cash flows report once the customer settles the invoice. Therefore, cash flow is a measure of liquidity.

This distinction explains why a business can be profitable while simultaneously experiencing cash flow difficulties.

Both numbers are critical and should work together to support business success. Profitability is important because it creates the foundation for future cash generation, but cash flow remains essential for day-to-day survival. After all, a profitable business cannot continue operating if it lacks sufficient cash to pay employees, suppliers, and other operating expenses.

Several warning signs may indicate that a business is facing cash flow problems despite reporting healthy profits:

• Bank balances are consistently declining despite reported profits

• The business frequently relies on loans or overdrafts to cover operating expenses

• Suppliers are not being paid on time

• Debtor balances are disproportionately high compared to sales

  
  

Ultimately, successful businesses understand that profitability and liquidity must work in harmony. While cash may be considered “king” in the short term, long-term success depends on maintaining both healthy profits and strong cash flow management. Businesses that effectively balance the present with the future place themselves in the strongest possible position to survive, compete, and thrive in their market.

Get in Touch:

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Jean Claude Cremona

jccremona@quazar.mt / +356 2388 4600