Cash & Profit: What's the Difference?

Explaining the subtleties and differences of two key components of financial literacy.

Everyone knows the importance of cash - cash is king, after all. Cash is likely the most valuable asset a startup could have at its disposal. However, most don’t understand cash’s complexities and how it is collected and leveraged. Many often confuse it with profit - though the two terms should not be used interchangeably and have slightly differing meanings. Both cash and profit need to be understood as they offer a glimpse into the company's financial health. Moreover, they each tell a seemingly different story that provides value to the company and its stakeholders.

The common myth that cash is equal to or identical to profit is untrue. The two financial metrics are more like fraternal twins than identical twins. They should be used together to understand the complete picture of a company’s financials, and understanding the difference is a key to financial intelligence. This article aims to clearly articulate the subtleties and differences between the two terms and outline how they can be used together to garner a greater sense of the company’s financial health.

Profit - The Bottom Line

Profit, or Net Income, is one of the most sought-after and highly regarded financial metrics; nevertheless, the bottom line - a crucial value that every manager wants to know - shows the company’s profitability.

Profit is created by the company’s ability to generate revenue. Once all costs and expenses are removed from the total revenue, the company can determine if they were profitable in that period. Profit is the amount left over from the company’s sales after considering the costs to create the product, operating expenses, other expenses, and all interest, taxes, depreciation, and amortization. Suppose the company has some of its original revenue left over. In that case, it is considered profitable - the opposite is true if there is nothing left over from the initial revenue or the various expenses are greater than the total sales.

Now suppose a company is on an upward trajectory. It’s gaining momentum and creating revenue far beyond its various costs and expenses, and the bottom line shows increasing profitability. With this increased demand, the company needed to keep up, so it began hiring additional staff, buying higher quantities of inventory, and improving its facility to ensure revenues continued to climb higher. However, they failed to consider that profit does not equal cash and that profit generated is not automatically converted to cash - meaning they are spending most of their cash on hand and running tight on money. Not understanding the difference between profit and cash has led to this company mismanaging its cash flow and putting it in a vulnerable position - even though it has been successfully profitable. This is a great example to show the importance of knowing the distinct differences between profit and cash - as a profitable company can run into trouble if they do not manage cash efficiently.

Cash - Money in the Bank

Unlike profit, which indicates if the company has generated more revenue than expenses, cash can be a bit trickier to track - as it weaves into and out of the business constantly, depending on several variables. The inflows and outflows of cash can be tracked in the Cash Flow Statement - which shows the beginning cash balance of a period, cash spent or received during the period, and finally, the ending cash balance.

Profits are not generally converted into cash immediately. Therefore, profitable companies can be cash flow negative because of this, meaning the company needs to manage its receivables and payables conservatively to ensure they have the money when debt and other obligations are owed. Alternatively, unprofitable companies can be cash flow positive - especially when a company is scaling upwards and slowly increasing sales. However, to have long-term success, a company should strive toward being both profitable and cash flow positive. This ensures they’re not only making money, but they’re able to satisfy all payables without the stress of money tied up in receivables or other current assets converting to cash as they have positive amounts of cash on hand for such occasions.

The differences explained here are not only outlined to ensure the reader can clearly and comprehensively understand what separates cash and profit - but also how the reader can use these highlighted differences to gather a fuller and more extensive perspective on the finances of a company and know what is happening if a company is unprofitable but has a positive cash flow or if it’s profitable with a negative cash flow. When studying a company’s financial performance, it’s best to look at both of these valuable metrics - not one over the other - to understand the intricacies of generating a profit and efficiently managing cash flow.

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