Cash flow and profit are essential financial metrics in business. Yet, it isn’t uncommon for those new to finance and accounting to occasionally confuse the two terms. Cash flow and profit arent the same things, and it’s critical to understand the difference between them to make key decisions regarding a business’s performance and financial health.
For investors, understanding the difference between profit and cash flow makes it easier to know whether a profitable company is a good, long-term investment based on its ability to remain solvent in times of economic crisis. For entrepreneurs and business owners, understanding the relationship between the terms can inform important business decisions, including the best way to pursue growth.
Here’s everything you need to know about cash flow, profit, and the difference between the two concepts.
Understanding the difference between cash flow and net income is crucial for anyone analyzing the financial health of a company. While they may seem similar on the surface, cash flow and net income measure very different aspects of a company’s finances.
In this comprehensive guide we will explain the key differences between cash flow and net income when each metric is more useful, and provide examples to drive the concepts home.
What is Cash Flow?
Cash flow refers to the actual amount of cash coming into and going out of a business during a specific time period. It provides a snapshot of how much liquid cash a company has available to fund operations, invest, and manage debt obligations.
The cash flow statement has three main components
- Cash from operations – Cash generated from day-to-day business operations
- Cash from investing – Cash used for investments and asset purchases
- Cash from financing – Cash from financing activities like loans and equity issuance
Adding up the cash from all three activities gives you the total change in a company’s cash balance during the reporting period.
Why Cash Flow Matters
While net income shows profitability on paper, cash flow shows the company’s liquidity and ability to generate enough cash to sustain the business. A company can be highly profitable on paper but still go bankrupt if it does not have enough cash coming in to pay expenses.
Strong operating cash flow also gives a company more flexibility to invest in growth, take on new projects, repay debt, and weather downturns. For all these reasons, cash flow can signal financial health and growth potential to investors beyond what net income alone shows.
What is Net Income?
Net income, also called profit or the “bottom line”, is a company’s total revenues minus total expenses over a period of time. It represents the residual profits left over after accounting for all costs of doing business.
The net income calculation is based on the accrual method of accounting, which means that revenues are counted when transactions occur rather than when cash is exchanged. The same goes for expenses – they are recorded when incurred, not necessarily when paid.
Why Net Income Matters
While cash flow shows liquidity, net income is important for showing the overall profitability of a company over time. It accounts for non-cash expenses like depreciation, which reduces taxable income without affecting cash flow.
Net income gives investors a standardized metric to compare profitability across different companies and industries. Growth in net income over time can signal a company’s improving business performance.
The Key Differences
Now that we’ve defined both terms, let’s summarize the key differences:
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Cash flow measures the actual cash coming into and out of the business. Net income measures profitability according to accounting standards.
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Cash flow is affected only by actual cash transactions. Net income includes non-cash expenses like depreciation.
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A company can have positive net income but negative cash flow, or vice versa. But over time, net income and cash flow should align directionally.
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Cash flow indicates liquidity and cash availability. Net income evaluates profitability and the bottom line.
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Cash flow comes from the cash flow statement. Net income comes from the income statement.
When Cash Flow Diverges from Net Income
For healthy companies, net income and cash flow should follow roughly similar trajectories over long periods, with perhaps some short-term divergence. But in some cases, especially with high-growth and high-investment companies, there can be sustained divergence between the two metrics.
For example, major infrastructure investments can weighed down cash flow in the short run but are not fully captured in the net income figure. Rapidly growing SaaS companies also commonly see this dynamic – high net income growth but lagging cash flow due to upfront subscription acquisition costs.
In cases of major divergence, analysts dig deeper to understand the disconnect and whether it is likely to persist or converge over time. The business model and stage of growth of the company also provides context on when divergence is more likely and whether it signals cause for concern.
Real World Examples of Cash Flow vs. Net Income
Let’s look at some real examples to see how net income and cash flow can differ:
High-Growth Company – Netflix
- Net income in 2018: $1.2 billion
- Cash flow from operations: -$3 billion
Netflix has grown net income consistently over the past decade. But cash flow has lagged as Netflix invests heavily in content acquisition and platform expansion. This divergence is expected given Netflix’s high-growth strategy.
Mature Company – Apple
- Net income in 2019: $55.3 billion
- Cash flow from operations: $64.1 billion
For a mature company like Apple, net income and cash flow are well aligned. The business generates strong cash flows to fund dividends, buybacks, and new growth initiatives.
Turnaround Company – General Electric
- Net income in 2018: $761 million
- Cash flow from operations: -$2.3 billion
GE has struggled in recent years with falling net income and negative cash flow as it goes through a difficult turnaround phase. But the metrics should realign as the business stabilizes and reduces its debt load.
Key Takeaways
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Cash flow represents the actual cash moving in and out of a business; net income measures profitability.
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Net income includes non-cash expenses while cash flow does not.
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For healthy companies, net income and cash flow directionally align over the long run.
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Analyzing divergence between the two metrics provides insight into the company’s finances.
The Cash Flow Statement
Cash flow is typically reported in the cash flow statement, a financial document designed to provide a detailed analysis of what happened to a business’s cash during a specified period of time. The document shows different areas where a company used or received cash and reconciles the beginning and ending cash balances.
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Profit is typically defined as the balance that remains when all of a business’s operating expenses are subtracted from its revenues. It’s whats left when the books are balanced and expenses are subtracted from proceeds.
Profit can either be distributed to the owners and shareholders of the company, often in the form of dividend payments, or reinvested back into the company. Profits might, for example, be used to purchase new inventory for a business to sell, or used to finance research and development (R&D) of new products or services.
Like cash flow, profit can be depicted as a positive or negative number. When this calculation results in a negative number, it’s typically referred to as a loss, because the company spent more money operating than it was able to recoup from those operations.
- Gross profit: Gross profit is defined as revenue minus the cost of goods sold. It includes variable costs, which are dependent upon the level of output, such as cost of materials and labor directly associated with producing the product. It doesn’t include other fixed costs, which a company must pay regardless of output, such as rent and the salary of individuals not involved in producing a product.
- Operating profit: Like operating cash flow, operating profit refers only to the net profit that a company generates from its normal business operations. It typically excludes negative cash flows like tax payments or interest payments on debt. Similarly, it excludes positive cash flows from areas outside of the core business. It’s sometimes referred to as earnings before interest and tax (EBIT).
- Net profit: This is the net income after all expenses have been deducted from all revenues. Typically, this includes expenses like tax and interest payments.
Information about a company’s profits is typically communicated in its income statement, also known as a profit and loss statement (P&L). This statement summarizes the cumulative impact of revenue, gains, expenses, and losses over the course of a specified period of time.
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Which Is More Important: Cash Flow or Profit?
Investors and business owners are often in search of a single metric for understanding the health of a company. They want one line item in a financial statement to determine whether they should make an investment or pivot their business strategy. In these instances, cash flow and profit are often pitted against each other. But which is more important?
There isn’t a simple answer to that question; both profit and cash flow are important in their own ways. As an investor, business owner, employee, or entrepreneur, you need to understand both metrics and how they interact with each other if you want to evaluate the financial health of a business.
For example, it’s possible for a company to be both profitable and have a negative cash flow hindering its ability to pay its expenses, expand, and grow. Similarly, it’s possible for a company with positive cash flow and increasing sales to fail to make a profit—as is the case with many startups and scaling businesses.
Profit and cash flow are just two of the dozens of financial terms, metrics, and ratios that you should be fluent in to make informed business decisions. By gaining a thorough understanding of key financial principles, it’s possible to advance professionally and become a smarter investor or business owner.
Are you interested in gaining a toolkit for making smart financial decisions and the confidence to clearly communicate those decisions to stakeholders? Explore our online finance and accounting courses and discover how you can unlock critical insights into your organization’s performance and potential. To find out which course is best for you, download our free flowchart.
This post was updated on February 2, 2023. It was originally published on April 21, 2020.
What’s the difference between net income and operating cash flow?
What is the difference between cash flow and net income?
Often referred to as “the bottom line,” net income is reported by public companies on both quarterly and annual income statements. Cash flow and net income share some similarities but they are different items with unique calculations and purposes. The cash flow statement and the income statement are completely different financial statements.
What is the difference between net income and cash flow from operating activities?
Net income is the profit a company has earned for a period, while cash flow from operating activities measures, in part, the cash going in and out during a company’s day-to-day operations. Net income is the starting point in calculating cash flow from operating activities.
Is net cash flow negative for a company?
It has often been seen that net cash flow is negative for a company even after earning a whopping profit. So, without looking at the cash flow statement, an investor cannot conclude about the performance of a company year by year. What is Net Income? Profit or net income is the “bottom line” of the company’s income statement.
What is the difference between operating income and total cash flow?
For instance, after a high, one-time asset sale, monthly net income may be higher than operating income, followed by a much lower quarterly net income. Total cash flow is the operative cash flow plus the net of the working capital of the company. The net of the working capital is the difference between assets and liabilities.
