Gross Profit, Net Profit & Cash Flow: Know the Difference
Two important financial metrics in small business accounting are cash flow and profit. Getting a grapple on their roles and differences is an important part of setting yourself up for financial success. To help small business owners understand the ins and outs of profit and cash flow management, Opulent Bookkeeping has broken down both concepts for you
What is a gross profit?
Defined as the amount remaining less the cost of goods or production but before the deduction of such other costs as rent or salaries.
Gross profit allows a business owner to understand how much money you need to make to create revenue. Moreover, it’s an important figure that tells you if your business is profitable. Either to the owners, shareholders – usually in the form of dividends payments, or reinvested back into the company to assist future growth, gross profits can be distributed numerous ways.
Calculating Gross Profit:
Total Revenue – Cost of Goods Sold = Gross Profit
Gross profit is calculated by subtracting the cost of goods sold (COGS) from the total revenue. Let’s say that your total revenue for a given week is $4,000, but it costs you $3,000 to make and sell your products or services to create that revenue. In other words, your gross profit margin for that week is $1,000. This number does not include any tax or business operating costs, such as rent, payroll or loan payments – that’s why we also look at your business’ net profit.
Gross profit is either positive or negative. Referred to as a loss, gross profits are negative when your business has spent more money operating than revenue created.
What is Net Profit?
Defined as the amount remaining when all expenses for manufacturing and providing a product or service and all business operating costs, including tax, payroll, rent loan payments and insurance, have been accounted for.
Net profit factors in liabilities beyond the COGS and therefore are a better reflection of your businesses’ profitability. This is because it includes all expenses such as your employees’ payroll, office rent, loan payments and other expenses not directly linked to the production of your business offering.
How to Calculate Net Profit:
Gross Profit – Total Expenses = Net Profit
Often referred to as the ‘bottom line’, net profit is also called ‘net earnings’ or ‘net income’ . This includes the ‘bottom line’ of a business, ‘net earnings’ or ‘net income’.
What is Cash Flow?
Cash flow refers to the movement of money in and out of a business. Money coming into your business is defined as inflow. Whereas money that is spent is defined as outflow. Why is this important? It determines your business’s short-term and long-term outlook.
Positive Cash flow is when you have more money coming into your business than you have going out at any given time.
Negative cash flow is when the amount of money going out of your business is greater than the amount of money you have coming in at any given time.
You should review your cashflow on a regular basis. Monthly or quarterly reviews are standard.
Cash Flow vs. Profit: What’s The Difference?
Both are important margins for business success. Profit is what is left once all expenses have been accounted for. Whilst cash flow shows the movement of money in and out of your business.
Which is more important for a small business: cash flow or profit?
One important question often asked by small new small businesses is: What should you look at? Cash flow or profit?
- Net profit is a better indicator for the success of a business as it looks at financial gains or losses over an extended period.
- Cash flow is important in keeping a business’ doors open.
In the long run, a lack of profit will negatively impact cash flow because your business will have a hard time retaining a positive cash flow. In other words, your net profit may be more indicative of your business’s success in the long-term. Moreover, Cash flow can indicate how well the business is maintaining profits on a day-to-day basis. Profits won’t save your business if they are not continuous and spent wisely.
Net profit is the revenue remaining after deducting all costs associated with operating your business producing and selling your goods or services. Whereas cash flow is the amount of money coming in and out of the business at any given time. Time is the main difference between the two. Cash flow only shows you a snapshot over a short period and doesn’t show you the whole picture of how your business is performing financially, something analysing your business’ net profit will allow you to see.
If you find yourself wanting assistance with your business finance management to better understand your business’s profits and cash flows, contact Opulent Bookkeeping today!