Startup Cash Flow Versus Profits: Do You Know The Difference?

Startup Cash Flow Versus Profits: Do You Know The Difference?

Read most news reports and business articles and you’d think profits were the sole determinant of business success. But in my experience, regardless of headline profit numbers, running out of cash is the number one reason startups fail. In fact, the distinction between profits and cash can be significant, and if they diverge too widely spell the difference between success and failure.

Here’s a quick primer on these two terms: what they represent, and why you need to closely monitor and effectively manage both.

Profits are a measure of earnings and business efficiency.

What do we mean when we talk about profits? It’s a good question to ask, because there are different types of profit: gross profit/income, operating profit/income, and net profit/income.

Cash Flow is a measure of liquidity.

Your startup cash flow statement is where you capture transactions that resulted in cash being generated or disbursed. Your operating cash flow number represents the cash you actually have available to meet your obligations.

To calculate that number, start with net income, then record all the subtractions or additions that impact it to arrive at a figure for your cash flow from operations. The most common subtractions are for Accounts Payable (what you owe), payroll, interest payments (if you’ve taken out debt), and taxes. Accounts Receivables reflects inflows from customer payments. Depreciation is added back because it is a non-cash expense that doesn’t reflect cash going out the door.

Preparing your financials isn’t always straight-forward and you may find you need help to get started, but the process of creating and regularly revising your financial forecasts gives you valuable information that you can use to improve your business model. The more iterations you go through, the more second nature it’ll become.

Now that you know the distinction between cash flow and revenue, here’s how you can take steps to tighten the link between the two:

Do you have questions about cash flow versus profits? Ask us in the comments section below or contact Early Growth Financial Services for a free 30-minute financial consultation.

David Ehrenberg is the founder and CEO of Early Growth Financial Services, a financial services firm providing a complete suite of financial and accounting services to companies at every stage of the development process. He’s a financial expert and startup mentor, whose passion is helping businesses focus on what they do best. Follow David @EarlyGrowthFS.

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