What's more important, cash flow or profits?

Cash flow and profits are both crucial aspects of a business. For a business to be successful in the long term, it needs to generate profits while also operating with positive cash flow.

Cash flow is the inflow and outflow of money from a business. It is necessary for daily operations, taxes, purchasing inventory, and paying employees and operating costs.

Positive cash flow indicates that a company's liquid assets are increasing, enabling it to settle debts, reinvest in its business, return money to shareholders, pay expenses and provide a buffer against future financial challenges. Negative cash flow indicates that a company's liquid assets are decreasing.

Profit is the surplus after all expenses are deducted from revenue. Profit is the overall picture of a business, and the basis on which tax is calculated.

There are three major types of profit that analysts analyze: gross profit, operating profit and net profit. Each type of profit gives the analyst more information about the company's performance, especially when compared against other time periods and industry competitors. All three levels of profitability can be found on the income statement.

When determining which one is more important, it depends on the business and the circumstances.

For example, a business may see a profit every month, but its money is tied up in hard assets or accounts receivable, and there is no cash to pay employees. Once a debt is paid or the business sees an influx in revenue, it starts to see positive cash flow again. In this example, cash flow is more important because it keeps the business running while still maintaining a profit. Alternately, a business may see increased revenue and cash flow, but there is a substantial amount of debt so the business does not make a profit.

The absence of a profit eventually has a declining effect on the cash flow. In this instance, a profit is more important. Another thing to remember when determining whether to focus on cash flow or profit is cash flow can be bought. A business owner can put up his or her personal assets as capital into the business or get a small business loan from a bank to keep the business running until it starts seeing cash flow again.

(For more, read What’s a Good Profit Margin for a New Business? or Profitability Indicator Ratios.)