What is More Important – Net Income or Cash Flow?
People who own a business or want to invest in one need to understand two very important numbers: net income and cash flow. Net income is the profit a company makes. Cash flow is the money moving in and out of the business. Both are super important, but in different ways.
Why Net Income Matters
Net income is the “bottom line” number. You start with all the money the business made, which is called revenue. Then you subtract all the costs of running the business, like salaries, supplies, rent, taxes. What’s left over is the net income. That’s the company’s profit.
Investors and banks look closely at net income. They want to see if the company is profitable. If net income is going up over time, that’s a good sign the company is healthy and growing. High profits also mean the company might be able to pay dividends to shareholders.
The Importance of Cash Flow
Cash flow is different from profit. It’s about the actual cash moving through the company. Money coming in from customers. Money going out to pay bills. A company needs to have enough cash on hand to cover costs like payroll, rent, supplies.
Positive cash flow means more money is coming in than going out. That’s a good thing. It means the company can pay its bills on time. Negative cash flow is a warning sign. The company is spending more cash than it’s bringing in. That can’t go on forever or the company will run out of money.
Profit Without Cash is a Problem
A company can be profitable on paper but still have cash flow problems. How? Maybe the company made a bunch of sales but the customers haven’t paid yet. The sales count toward profit, but the cash isn’t in the bank yet. Meanwhile, the company has bills to pay now.
Or maybe the company is growing fast and spending a lot of cash to buy inventory and hire people. Profit can be high but cash can be tight. This is common with fast-growing startups. They’re making money but burning through cash to grow.
Cash Without Profit is Also a Problem
The flip side can also happen. A company can have plenty of cash but not be profitable. How? Maybe they’re getting a lot of investment money or loans but they’re spending more than they’re making in sales.
Having cash is good for paying bills in the short term. But if the company keeps losing money, eventually the cash will dry up. Investors will stop investing. Banks will stop lending.
So Which is More Important?
The truth is, you need both. Profit and positive cash flow. In the short term, cash flow might seem more important because you need cash to keep the lights on. But in the long run, profits are essential. Without profits, the company isn’t viable.
Balancing Act
Smart business owners and managers keep a close eye on both net income and cash flow. They make sure the company is profitable and that there’s enough cash coming in to cover costs.
Sometimes that means making hard choices. Delaying a big purchase to conserve cash. Offering discounts to get customers to pay faster. Cutting costs to boost profit. It’s a constant balancing act.
Planning Ahead
The key is planning ahead. Having a budget and a cash flow forecast. Knowing when big expenses are coming up and making sure there will be cash to cover them.
For example, if a company knows it has a big tax bill coming up, it might need to be extra careful about spending in the months leading up to that. Or if a manufacturer knows a key piece of equipment will need replacing soon, they should be setting aside cash for that.
The Danger of Ignoring Either One
Companies that focus only on profit and ignore cash flow can suddenly find themselves unable to pay their bills. They might be forced to take out expensive short-term loans or even go out of business.
On the other hand, companies that focus only on cash and not profit are just delaying the inevitable. Eventually they’ll run through their cash if they keep losing money.
The Bottom Line
The bottom line is that both net income and cash flow are critical. They’re like two vital signs for the financial health of a company.
Net income shows if the company’s core business is profitable. It’s what investors and lenders look at to gauge the long-term prospects of the company.
Cash flow shows if the company is managing its cash position well in the short term. It’s what keeps the company from bouncing checks or missing payments.
A Holistic View
The smartest business owners and investors look at both numbers and understand how they interact. They know that a profitable company can still have cash flow challenges. And they know that a company with plenty of cash can still be in trouble if it’s not profitable.
It’s about taking a holistic view of the company’s finances. Looking not just at the bottom line profit number but at the actual cash flowing in and out. Making sure there’s enough coming in to cover what needs to go out, not just today but in the months ahead.
Getting the Timing Right
A lot of it comes down to timing. Sales and expenses often don’t line up perfectly. A company might have a big sales month but not see that cash come in for 60 or 90 days. Meanwhile, they have expenses to pay now.
That’s where good financial planning and management comes in. Using tools like invoicing and collections to get money in faster. Negotiating better payment terms with vendors. Having a line of credit for short-term cash needs.
