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Cash Flow vs. Profit: Understanding the Difference

A real estate records her numbers for the week on a laptop,

When you’re running a business, keeping track of all of the financial terms can be enough to give you a headache! But two of the most important terms that will affect you are your cash flow and your profit.

Cash flow refers to the net flow of cash in and out of a business, while profit indicates the amount of money that’s left over after all of the expenses have been paid. 

A business can be very profitable while having poor cash flow. The opposite is also true — a robust cash flow doesn’t mean a business is necessarily profitable. Investors and business owners alike use these important metrics for things like deciding when to invest or what business strategies should be used. 

It’s especially important for businesses to consider and calculate the demands of cash flow vs. profit accurately. Accurate bookkeeping is essential for both forecasting cash flow and calculating business profits, regardless of the size of your business. 

The Difference Between Cash Flow and Profit

To manage your business effectively, it’s a good idea to have a firm grasp on business cash flow vs. profit. As a business owner, you need to not only understand the differences between the two terms, but also to be able to leverage both to your advantage. 

Cash Flow

Cash flow consists of all money that comes in and out of your business over time. Positive cash flow happens when there is more money coming in than going out, while negative cash flow means that there is more money going out than coming in. 

However, there are certain things not included in business cash flow, which include:

  • Money owed to creditors
  • Money in the bank 
  • Credit from suppliers

Business cash flow is used as a metric to determine the health of your business. Lenders and investors may use it to assess how well your business is doing. 

Profit

Put simply, business profit is revenue minus expenses; it is also referred to as “net income.” 

When it comes to calculating business profits, there are two types of profits:

Gross Profit

Gross profit is the profit of your business after deducting the costs it takes to provide goods and/or services. 

Net Profit

Net profit is the profit after everything — including taxes and operating expenses (such as payroll, rent, utilities) — have been deducted.

Cash Flow vs. Profit:  Which is More Helpful for Understanding Your Company’s Health?

When it comes to business cash flow vs. profit, which is more helpful for understanding the health of your company? 

Many business owners — along with investors — want to know the one metric that will determine the health of the business so they can decide the direction to take with their business strategies. Unfortunately, there isn’t a simple answer to the business cash flow vs. profit question because both cash flow and profit are important to the health of your business, albeit in different ways. 

Business profit illustrates the immediate and short-term success of your business. Alternatively, cash flow can be used to more accurately determine the long-term financial outlook of your company. 

To be successful in the long run, a business needs to maintain both positive cash flow and profit. The critical difference between business cash flow vs. profit is time.

Understanding how these two interact can help you to make better business decisions. 

Understanding Cash Flow

Obviously, every business desires to increase sales; however, if cash flows do not increase at the same rate as your sales, you can find your business actually running short on cash. 

For example, for a business, selling more products often means spending more cash (an outflow of cash) to buy the products to stock the shelves or inventory; however, the cash inflow from sales may not be immediately available for use.  

Business growth is important for profit. Though it seems contradictory, growing your business can result in cash flow shortages. For example, when growth is high, a business may accept more orders but not have enough cash to produce and deliver them. 

Cash flow is the lifeblood of any business, so it is important to manage your cash flow carefully. There are several options available for managing small business cash flow, which we’ll explore in depth below.

Delay Cash Payments

Delaying cash payments to suppliers reduces the immediate need for cash. For example, when you’re purchasing products, you may negotiate with the supplier to pay a certain percentage upfront and then pay the remaining balance within a certain amount of time, say a month or six weeks. 

The advantage to this kind of arrangement is that you don’t have to put up all the cash upfront to get the product, but you are in effect borrowing against your future business because you will have to pay out when the delayed payment comes due. 

Cash Collections on Previous Sales

For various reasons, you may not immediately receive the cash from your sales upfront. Similar to delaying payments to a supplier, there may be a delay in receiving cash from the products you sell and deliver. 

For example, cash from June sales may not be available until July. The risk of this is that you could be short of cash in June and not have enough to meet all of your outflow needs for that month, even though June was a busy month. 

Raising Capital

If you do not have sufficient amounts of short-term cash, raising capital may be an option. One way to raise capital is to borrow money. If your business is big enough, you can issue stock, which means that an investor gives you cash in exchange for purchasing a piece of ownership of your company. 

If you are under pressure, you may feel compelled to accept a loan with a higher interest rate than you’d like or sell more ownership than you would prefer.

Both these ways of raising capital have downsides, which makes raising capital the least attractive cash flow management option. Borrowing money means that you will have to pay it back in the future, often along with interest. 

Issuing stock means selling a part of your business. Depending on the percentage and terms, it may mean that someone else may be entitled to have a say in the way that your business is run. 

Understanding Profit

Increasing business profits can be beneficial for your company; however, it is always important to remember that any new source of profit (such as developing a new product or adding a new service) may also raise your expenses. 

Because this could push your costs beyond what is feasible (and result in an overall loss of profit), calculating business profit on new ventures is very important. Small business profits may be especially vulnerable to upfront costs for new lines of products or services. 

Plan Carefully

Small business cash flow considerations are particularly important because newer businesses may have less cash flow to draw on. 

Regardless of the size of your business, good planning involves careful and accurate bookkeeping. This is essential for both legal and financial purposes. Moreover, it can help you manage cash flow vs. profitability

With the advent of the Internet, online bookkeeping has become an advantageous way to track your business accounts. Accurate, up-to-date records will give you a snapshot of the health of your business, as well as your cash flow. 

Timely bookkeeping can also help you avoid the need for catch-up bookkeeping. However, if you do need to catch up, Xendoo can certainly help. 

Putting It All Together

Though higher business profits are an understandable goal for any business, you must plan carefully to balance cash flow vs. profit. As noted in this article, it is possible for a business to be profitable, but still have poor cash flow. 

Conversely, a business can have robust cash flow but have little profitability. To properly manage both business cash flow and profits, you need accurate, timely bookkeeping. 

 

Bringing Home the Bacon: A Profit Growing Guide for Restaurateurs

Editor’s Note: This post was originally published in February 2017 and has been revamped and updated for accuracy and comprehensiveness. 

It’s no secret that the restaurant business is tough, even in the best of times. Really tough. Even before the COVID-19 shutdowns, industry analysts estimate the failure rate for new restaurants in the first year was somewhere around 60%, with another 20% shuttering the doors before the 5-year mark. That’s only gotten worse during the pandemic, with hospitality being one of the industries hardest hit by shutdowns and restrictions. However, as bleak as that reality may seem, the restaurant industry is still viable, and there are things you as an owner can do to help increase restaurant profits and make sure you stay in the 40% that do well.

Understanding Profits: Gross vs. Net

When discussing how to increase restaurant profits, it’s important to distinguish between gross profit and net profit. Gross profit for a restaurant is defined as the price of the item minus the cost of goods sold, i.e., food cost. For example, if your signature lasagna dish sells for $20 and the ingredients to make it cost $7, your gross profit on that item is $13, and your profit margin is 65% (13 divided by 20). Industry norms and best practices suggest that food costs should run somewhere around 30%, which means that if your total sales for the month are $100,000, you should be spending roughly $30,000 with your foodservice vendor. Food costs that run higher than that can often be an indicator of excessive waste or theft (often referred to as shrinkage), so it’s essential to know your gross profit margin.

Net profit is the amount left over after ALL operating expenses are deducted, not just food costs. That includes expenses such as labor, food cost, rent, utilities, equipment repairs or leases, insurance, etc. Because it consists of a much more expansive list of expenses than gross profit, net profit will necessarily be a much smaller number. Typical net profit margins have shrunk in recent years but typically hover around 3-5%.

It’s critical to stay on top of your books and know exactly what your margins to increase restaurant profits because if you’re playing catch-up bookkeeping, you’re flying blind. Generally, when discussing how to increase restaurant profits, most people mean net profit because it’s the one that keeps the lights on for your business. With that in mind, there are two ways to boost your bottom line – you can increase sales or lower expenses. So let’s look first at ways to boost your sales numbers and increase your average ticket price or cover the average.

View of a restaurant menus with prices set for increase in profits

Review Your Menu Pricing

As we noted above, your food cost should be around 30% of your menu price, so you’ll need to calculate the plate cost of each menu item to help increase restaurant profits. To do this, first, make a list of each ingredient required to prepare the dish. Next, choose which unit of measure your foodservice vendor uses for the items (e.g., do you buy it by the pound, gallon, dozen, etc.) and identify your unit cost from your vendor. There may or may not be a yield percentage for the item, which would be waste from trimming or peeling the item before use. For example, certain cuts of meat may require trimming away fat or gristle, which reduces its useful yield. These can usually be found in standardized yield charts available from many vendors. 

Finally, do a similar calculation for the way you prepare the dish:

1.  Select the correct serving unit, which is usually as simple as the unit of measure that your recipe calls for.

2. Calculate the serving unit cost by dividing the cost per measure by the number of serving units per measure. The cost per measure for items with no yield is the unit purchase price, and for items with a yield, the unit purchase price is divided by the yield percentage. For example, if you buy ground beef for $4 per pound and your serving unit is ounces, the serving unit cost would be $0.25 per ounce ($4 divided by 16 ounces to the pound).

3. Select your portion size, which is the quantity called for by the recipe.

A simple plate cost for a hamburger and fries might look like this, assuming four potatoes to the pound and six slices per tomato:

Ingredient Purchase Unit Purchase Unit Cost Yield Actual Unit Cost Serving Unit Serving Unit Cost Portion Size Portion Cost
Ground Beef Pound $4.00 N/A $4.00 Ounce $0.25 5 $1.25
Bun Dozen $6.00 N/A $6.00 Each $0.50 1 $0.50
Tomato Pound $1.89 N/A $1.89 Slice $0.31 2 $0.62
Mustard Gallon $13.00 N/A $13.00 Ounce $0.81 1 $0.81
Potato Pound $2.00 .81 $2.46 Each $0.62 1 $0.62
$3.80

So we can see that the plate cost for this hamburger and fries meal is $3.80. Sticking to the rule of 30% food cost, the menu price of this item should be $12.50. If it’s less than that, it’s probably eating into your bottom line.

Identify Your Menu Hits and Misses

Now that you know your plate cost for each item on your menu, it’s time to compare those to some sales reports from your point-of-sale (POS) system to see where your profit is coming from. Create a spreadsheet with four categories and label them “HIGH PROFIT/HIGH SALES,” “HIGH PROFIT/LOW SALES,” “LOW PROFIT/HIGH SALES,” and “LOW PROFIT/LOW SALES.” Then, put each item on your menu into one of those categories to see where each item falls. Dishes that fall into the “LOW PROFIT/LOW SALES” category are candidates for removal in favor of more profitable offerings. Also, consider running daily specials that combine high-profit, low-sale items with big sellers to help move those lower selling items to get that incremental revenue.

Up-Sell and Cross-Sell Effectively

It’s impossible to overstate the importance of staff training in proper selling techniques to increase restaurant profits. Train your service staff to offer customers an appetizer or cocktail before starting their meal, and train them to make quality recommendations. If you are a full-service restaurant and serve alcohol, educate your staff about wine types and selections that you carry. Distributors will often send a representative to do this training for you at no cost. Armed with that knowledge, the staff then knows that the new full-bodied cabernet that just came in yesterday goes wonderfully with a steak dinner and can offer that to a customer considering the steak. The result is a happier customer with a higher ticket who will tell his or her friends about your knowledgeable staff. Run contests to reward the servers with the highest average ticket for the week to encourage up-selling.

In addition to some general restaurant bookkeeping tips, let’s look at some specific ways to manage your operating expenses and keep your bottom line healthy.

Watch Your Invoices Closely

Food prices constantly fluctuate due to various factors, with some items varying wildly. It’s important to know exactly the current price of a pound of shrimp. If that price begins to rise due to an oil spill, hurricane, or another event that causes a shortage, it might be prudent to take the shrimp cocktail off the appetizer menu for a little while if the price gets too high. Also, some food service vendors will try to get your business by initially offering you low prices that they can’t sustain with the intention of creeping the prices up slowly in the hope that you won’t notice. This practice is called “speeding.” Be sure to regularly compare pricing from different vendors to ensure that you’re getting the best price when your food truck comes in.

A server sets tables at a restaurant.

Manage Your Labor

Along with food cost, labor is the other big variable expense that operators can control to increase restaurant profits. Labor is often a very fine line to walk. Too much labor during slow times is an unnecessary expense and may dilute tips among servers and affect their morale, while too little staffing can result in poor customer service and quickly land your business in Yelp hell. Many modern point-of-sale (POS) systems include advanced scheduling that uses sales history to predict how many servers you will need at any given time. Many POS systems can even suggest your best-selling servers on your busiest shifts for you. If you have such a system, take advantage of these features to keep your staffing lean and mean. If you don’t, it might be cost-effective to consider upgrading.

Stick to Multi-Purpose Ingredients

When planning out your menu, try to avoid items that require ingredients that aren’t used in any other dish. For example, if nothing else on your menu uses shrimp, you should probably avoid putting the shrimp cocktail on your appetizer menu because shrimp is expensive and has a short shelf life. But if your menu includes a grilled chicken salad and lemon pepper chicken, the chicken quesadilla pinwheels might be a better appetizer for you. By sticking to ingredients that are used in multiple dishes, you can cut down food costs and waste significantly.

Take Regular Inventory

Taking regular inventory is one of your best tools to detect waste and theft, so set a schedule to take a detailed inventory regularly. Compare it to your sales report to see if the sell-through rate matches what you expected from your sales report. That way, you know which items are moving and which are sitting on the shelf too long, and whether you might have some product walking out the back door at night. Have it conducted by at least two people to ensure that it’s done accurately and honestly. 

Get a Handle on Your Bookkeeping

Good bookkeeping for restaurants is essential, and as a restaurant owner, you probably don’t have the time to be doing your books. Your focus needs to be on doing what really matters – growing your business and improving your bottom line. That’s where a partner like Xendoo can help by offering a full suite of business bookkeeping products and services to help you know where every dollar is going. Outsourcing is more affordable than you might think, and it can pay for itself very quickly. Economists call it “opportunity cost.” It’s the hidden cost of foregoing one opportunity in favor of another because you don’t have time to do both. Yes, assuming you have the knowledge, you might save a few dollars in accounting fees by doing it yourself, but how much will your business operations suffer because you’re spending all your time on that?

This post is intended to be used for informational purposes only and does not constitute as legal, business, or tax advice. Please consult your attorney, business advisor, or tax advisor with respect to matters referenced in our content. Xendoo assumes no liability for any actions taken in reliance upon the information contained herein.