Operating Profit Sales Revenue Generated from Regular Activities
Cash flow refers to the amount of money being transferred into and out of a business. Profit is the money a business pulls in after accounting of all expenses. The three major types of profit are gross profit, operating profit, and net profit, all of which can be found on the income statement.
Like cash flow, profit can be further broken down into three categories:
- 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.
Cash Flow vs. Profit: What’s the Difference?: HBS Online. (2020, April 21). Retrieved November 02, 2020, from https://online.hbs.edu/blog/post/cash-flow-vs-profit
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Kenton, W. (2020, August 28). Understanding Profit. Retrieved November 02, 2020, from https://www.investopedia.com/terms/p/profit.asp
The answer to this is because they are two different things. Cash flows are literally the amount of cash inflowing and outflowing within a company. Profit is simply the difference between sales and costs in a given time frame. Now, they are very closely related. A business can be profitable and still have negative cash flows. Maybe in one quarter there was a rather large business expense, or a large purchase on credit. The negative cash flow is typically a short term problem. A business with long term cash flow issues will likely not be profitable for long, and eventually lead to it’s failure. Positive cash flows are necessary to be able to pay debts, suppliers, etc. When a business is unable to pay what they owe to others, it’s a bad sign.
Cash flow and profits are related but are not necessarily going to be the same figure. If a business is profitable, it should, in theory, be generating positive cash flow. However, this is not always the case, and an income statement is based on an accrual basis and not a cash basis; which in an accrual basis, this is because an item has been sold that is not a guarantee the sale was in the form of cash. It may be sold on credit and not yet been collected from accounts receivable (“Business Planning Papers,” n.d.).
A business can also have the cash it invests into fixed assets that do not show up anywhere on an income statement. Besides, expenses may be incurred but not yet actually paid out from the cash account, and the statement of cash flows reflects three components, operating, investing, and financing. Operating incorporates the actual results from operations (items normally shown on an income statement). Investing reflects activity and cash spent on fixed assets. Financing shows funds related to outside financing activities like a mortgage or loans. It is important to understand a business’ cash flow by comprehending all the different components of a cash flow statement. It can better position the owner on the true costs of running the business (“Business Planning Papers,” n.d.).
Business Planning Papers: Making Cash Flow Forecasts. Cash Flow Plan Cash Flow Planning Profit Analyse Forecast Improve Project Cashflow Statements. https://www.planware.org/cashflowforecast.htm.
As an investor, the statement of cash flows is important. The statement of cash flows tells you how much cash went into and out of a company during a specific time frame such as a quarter or a year. The statement of cash flows is very important to investors because it shows how much actual cash a company has generated. The income statement, on the other hand, often includes noncash revenues or expenses, which the statement of cash flows excludes. One of the most important traits you should seek in a potential investment is the firm’s ability to generate cash. Many companies have shown profits on the income statement but stumbled later because of insufficient cash flows. A good look at the statement of cash flows for those companies may have warned investors that rocky times were ahead.
The Statement of Cash Flows. (n.d.). Retrieved November 02, 2020, from http://news.morningstar.com/classroom2/course.asp?docId=142913&page=4&CN=COM
The four main types of financial statements are the balance sheet, the statement of cash flows, the income statement and the statement of equity changes. For this discussion questions I’ll choose the income statement. The income statement shows us the company’s profits and losses for the given period. It shows us the revenues that have been generated, as well as the different expenses the business has had. Essentially, the income statement tells us how efficient a company is being ran. In my opinion, this is the most important financial statement. However, to make a sound decision, one would likely want to analyze the different statements to get a more complete picture. Each type of financial statement plays a different role.
Income statement is one of a company’s core financial statements that shows their profit and loss over a period of time. The profit or loss is determined by taking all revenues and subtracting all expenses from both operating and non-operating activities. This statement displays the company’s revenue, costs, gross profit, selling and administrative expenses, other expenses and income, taxes paid, and net profit, in a coherent and logical manner. Stock investors rely heavily on the income statement, this is because it gives them an understanding of the businesses profitability and future growth. This is because they are mainly concerned with whether or not investing their money in the company will yield them a positive return. Internal users like company management and the board of directors use this statement to analyze the business as a whole and make decisions on how it is run.
Chen, J. (2020, October 11). Income Statement. Retrieved November 03, 2020, from https://www.investopedia.com/terms/i/incomestatement.asp