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Cash Flow vs Profit in the HK: What’s the Difference?

Author Melissa YeoMelissa Yeo

8 min read
Money Talk

Those who run e-commerce businesses often worry about profits but ignore the value of cash flow. Understand the difference between profit and cash flow.

Cash Flow vs Profit in the HK: What’s the Difference?

Cash flow and profitability are not the same. As an entrepreneur in the HUK, it’s important to understand the difference and benefits of both terms if you want to ensure smooth day-to-day business operations. That means balance, strategic thinking and most importantly a firm grasp of financial terms that relate to the accounting of your HK ecommerce business.

The definition of cash flow is a good place to start. Cash flow is the net amount of cash and other equivalents that move in and out your company and are reflected in your financial statements. Profit is the financial benefit when revenue generated by company activities surpass those costs, expenses and taxes associated with sustaining business activities.

Profit is crucial to any business but having a firm finger on the pulse of a business’s financial health ultimately depends on cash flow. You could be profitable and yet unable to pay the bills if your business cash flow is lacking. Even if you’re meeting all financial obligations, without a positive cash flow, your business isn’t necessarily making a profit. Timing is everything when it comes to cash flow. You might be making money over a month or year, but you may find yourself struggling on specific days/weeks if there’s not cash flowing into your business.

Elizabeth’s online apparel business makes an average of HKD $1,000 in profits per month. However, this amount is only credited to her business bank account at the end of the month. Since her bills are due at the beginning of the month, she has problems with paying her bills and finds herself having a cash flow problem. In this situation, she would have to review her processes, eliminate excess expenses and gradually improve her cash flow.

What Is Cash Flow?

Cash flow is the net amount of moolah that moves into the record books of your business’ finances at any specific time. It’s more than often a constant. It’s expected that cash will be moving in and out of your business as a part of your day-to-day business operations. Cash flow has the potential to be both negative and positive.

When goods for sale make their way to suppliers, cash flow is negatively affected on the books. Simply put, negative cash flow is the state of having more money flowing into a company, than out of it. On the other hand, just as it sounds, positive cash flow is a good thing. It means there’s more cash flowing into the business’ books than whatever amount is flowing out.

Consider Elizabeth’s kids plush toy business. When a product from Mouse Made This is sold, it means her inventory is depleted and the item purchased (essentially representing cash) moves from being a part of her business stock and into the hands of a new customer. The artisans who sew and assemble her products also need to be paid, along with bills owed to debtors - like rent and utility expenses.

Types of Business Cash Flow:

  • Operating cash flow: Net cash produced as a result of your business operations is known as “operating cash flow”. This is important to remain in the positive if you want to maintain business growth and keep expanding.
  • Investing cash flow: Net cash your business generates from activities that are investment-related is known as “investing cash flow”. This could be anything from property or asset sales to securities and equipment. If you’re actively investing in your business, which many healthy businesses do, your investing cash flow is likely to often be in the negative.
  • Financing cash flow: Net cash that’s generated by your business and subsequently used to finance the company’s operations - moving between creditors, shareholders or investors - is known as “financing cash flow”. Enquity, dividend payments and even debt can be included as financing cash flow.

What’s the Meaning of a Cash Flow Statement?

A cash flow statement is an important financial document for any business owner. It’s where you track and report the flow of your business’ cash over set periods of time, for example over the course of a Financial Year in the UK. This detailed analysis of financial activity serves as an accurate representation of how cash moves in, out and is reconciled in final balances.

What Is Profit?

Once you’ve subtracted operating expenses and balanced the books, the revenue you’ve got left is what’s known as “profit”. Typically, this remaining amount is distributed in different ways - it can be paid out as dividends to shareholders and owners or reinvested back into the company as a way of enhancing the business overall. Selling or purchasing new inventory, products or services or even allocating a budget to R&D could all be considered ways of reinvesting profit.

Just as we covered with cash flow, it’s important to consider positive and negative depictions of profit in your financial statements. The bottom line is that negative profit numbers denote a loss. This is because it indicates that costs exceed the amount able to be recouped in the process of normal business operations.

Types of Business Cash Flow:

  • Gross profit: Revenue minus the cost of goods sold is known as “gross profit”. While it doesn’t include fixed costs, it is affected by costs factored into the labour and raw material it takes to produce products. Gross profit is usually a variable figure.
  • Operating profit: Net profit earned through normal business operations is known as “operating profit’. This figure excludes tax, interest payments and cash flow that comes in through streams that fall outside of your core business. Operating profit is also known as earnings before interest and tax, and referred to by the acronym EBIT.
  • Net profit: After all expenses (interest payments and tax etc) is deducted  from your revenue, the income you have remaining is your net profit.

Which One Is More Important to a Business?

To answer this question, you need to look into the particular circumstances of your business. You may see monthly profits but if they’re not liquid (i.e if they’re tied up in accounts receivable or other physical assets), you won’t have cash flow to pay your employees. To start to see positive cash flow figures, there’s a need to either settle any debt or have your business revenue increase significantly. In a case like this, it’s evident that cash flow is more important as it’s an important factor in the sustainable running of your business, while still drawing a profit.

Without profit, cash flow will be negatively affected and that means it’ll decline over time. This is an instance where profit is more important to your business. If you’re at a crossroads in determining whether you need to focus on the importance of cash flow over profit, keep in mind that you can buy cash flow. Personal assets can be put up as capital or you can also apply for a small business bank loan to tide you over a tricky period.

If you’re not profitable on paper, it is an indication that the company is not in good shape and you would have to increase your sales or decrease your expenditure to keep things running. On the contrary, even if your company is profitable, this does not mean that your business can operate on autopilot. You will still have to keep an eye on your cash flow so you can continue moving in the right direction.

Can Growth Lead to Cash Flow Problems?

Growth has positive connotations for sure, but it can also affect the ability of your business in generating or maintaining cash flow. That’s why understanding these terms and how they influence the longevity of your efforts is an important priority for any business owner.

If you experience a business growth spurt and accept too many orders without having the cash flow that’s needed to actually produce them and meet the demand, you may find yourself in a tight spot. With a business loan or the sales of stock, you could get back on track but the best approach is to not have to go down that road by anticipating when it’s time to pump the gas, or hit the brakes.

How To Calculate Your Operating Cash Flow Ratio

The operating cash flow ratio, also known as a liquidity ratio, is an indicator of whether the cash generated from a company's operating activities can repay its current liabilities.

To work out this number, simply follow this formula:

Operating cash flow = Cash flow from operations/ current liabilities

Cash flow from operations: this number can typically be found on your company’s statement of cash flows. Otherwise, use the following formulation to calculate your cash flow from operations:

Cash flow from operations = non-cash expenses + net income + changes in working capital

Current liabilities: this refers to the obligations that are due within a year, including accounts payable, short-term debt and accrued liabilities.

Helpful Cash Flow Management Tips To Grow Your Business

These tips will help you practise effective cash flow management that’ll help you set priorities for business spending:

  1. Maintain your books properly

Maintaining your books properly means recording transactions, keeping track of payments and invoices to understand where your money is. When done correctly, it becomes effortless to trace back later to sort out the profits and losses you require for tax or auditing purposes.

If it feels overwhelming, consider outsourcing your bookkeeping. This means you’ll have an expert to manage your cash flow and point out any financial shortcomings that need addressing. Our team at Osome can help you sort out your books in minutes and reconcile them every 24 hours so you don’t have to waste precious time retracing old invoices.

  1. Monitor cash flow

Cash flow management involves close monitoring of cash flow. Keep an eye on the amount of money you have spent, how much you have on hand, and how much you will have soon after receiving the money owed to you. Develop a daily cash report to understand what your business can spend without needing to delve deeper into credit or debit. This report can also provide crucial information on profit, loss and expansion possibilities.

Pay attention to your current financial situation and look out for patterns, including how long your clients take to make bill payments. This puts you in a better position to identify problem areas and effectively act on them.

  1. Forecast the following month’s cash flow

A good cash flow forecast allows you to prepare for periods when cash might run low. It is always important to make plans ahead so you can work out contingency plans for your company to sustain during times of negative cash flow.

Every business faces challenges with varying demands. While there is no guaranteed method of forecasting the exact cash flow you require week-on-week, it would be helpful to estimate the expenses you would require. As a gauge, run through a typical week in your business and use that to plan and practise better budgeting for the upcoming week. In this way, you can predict the amount you will have in your bank at the end of the month, regardless of your business’s profitability.

Benefits of Maintaining Healthy Cash Flow

Maintaining positive cash flow preserves liquidity in your company and helps contribute to growing your business. Practising cash flow management allows you to witness these benefits:

Meet and pay obligations on time

With healthy cash flow, your business can make timely repayment of obligations. In the long run, this will help to strengthen the business relationship with your suppliers and third parties. Should unfortunate cash flow-related circumstances arise in the future, your working partners may be empathic and extend credit terms. Additionally, if you need financing,  a record of timely repayments reflects well and aids in your credit rating.

Alleviate the pressure of unexpected expenses

Unforeseen circumstances including financial crises, pandemics and natural disasters can put your business under tremendous pressure. Having healthy cash flow at times like this helps alleviate unnecessary stress. With adequate cash flow, you can have peace of mind knowing that your business’s daily operations can run smoothly and you can meet your financial obligations. This allows you to concentrate on expanding and building a successful business.

Grow the business

If you are looking to expand your business, good cash flow management can mitigate dependence on external resources. In a situation where you require a bank loan, you would also be in a stronger financial position to discuss repayment terms and interest rates.

Get Your Paperwork in Order and Stay on Top of Your Finances

The amount of cash flowing through your business is crucial for its success. We’re here to help you to collect daily data from different online sales platforms and convert it into your accounting books. Get in touch if you want to take accounting and admin off your chest. By the way, we also assist when you need a hand with company secretarial tasks in Hong Kong. Talk to us to learn more.

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