Don't Mix Up Cash Flow and Profit

Cash flow is a gross measure of all funds delivered to a company, while profit is a net amount earned in a given term. On any financial statement, a company will list its cash flow as part of necessary accounting statements required by the Securities and Exchange Commission (SEC) and the Internal Revenue Service (IRS). While cash flow can measure the health of a business, profit is a more accurate measure of how much an investor could project to earn by being involved with that company.

Financial Statements

Companies are required to issue financial statements if they wish to list shares on the open market. They will all include features required by Generally Accepted Accounting Principles (GAAP). These features include a balance sheet, an income statement and a cash flow statement. The balance sheet shows a comparison of the company's assets and debts. The income statement shows earnings in a given period. The cash flow statement shows how much the company let out in funds and how much they brought in in funds. None of these is a measure of profit.

Positive and Negative Cash Flow

Cash flow is basically a measure of trade. Like a country's trade balance, a company's cash flow can be either positive or negative. If the company paid out more than it was paid, it will have a negative balance. If a company was paid more than it paid out, it will have a positive cash flow. Positive cash flow is a definite goal, but it also is not a measure of profit.

Types of Cash Flow

Cash flow can come from three sources: operating, investing or financing. With operating funds, a company has earned money by providing a good or service to the market. Through investments, a company can also expand its capital without any operating expense. Finally, by providing financing, a company can earn money by lending money. Each of these will result in cash flow. Operating cash flow is the most expensive to achieve. To generate a profit through operation, a company must first produce a good or service, pay employees and market that service to the public. With investment cash flow, however, the company simply pays a few transaction fees in order to achieve earnings. Companies with greater investment and financing cash flow will have lower expenses, which can ultimately increase their profits.

Interpreting Cash Flow vs. Profit

Cash flow is highly correlated with profit, but the two are different measurements. If you spend $50 on supplies for a lemonade stand and earn $75, you had a high cash flow. Imagine you have a neighbor who earned only $30 but also spent only $5. Your profits were exactly matched. For this reason, profit is a better measure of financial vitality than is cash flow; profit accounts for operating expense. Some industries have a very high cash flow. For example, an automobile manufacturer has high cash flow due to the price of its products. However, the cost to manufacture its product is also high, and its profit may be lower than that of a simple candy store.

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