What’s the Difference Between a Cash Flow Statement and a Profit & Loss Statement?

Cash flow statements and profit and loss statements are two kinds of financial statements that a business owner must produce every month to measure their business' financial health. 

The main difference between a profit and loss statement and a cash flow statement is that a profit and loss statement measures the profitability of the business model while a cash flow statement shows where your money is coming from, where it's going, and how much cash you actually have on hand at a given point in time. 

Understanding your cash flow statement vs profit and loss statement is essential for ensuring a viable, financially healthy business.

Profit and Loss Statement

In many ways, the profit and loss statement is the simplest kind of financial statement to prepare and understand in small business bookkeeping. This kind of income statement records revenue and expenses for each month to see whether the business is making or losing money overall. This, in turn, will help you work out whether you need to increase your profit margins or lower your expenses to ensure that your business is sustainable over the medium- to long term.

Accrual Accounting Method

To get a clear picture of how profitable the business is, the profit and loss statement is prepared using the accrual accounting method—that is, recording revenue and expenses when they occurred rather than when the money actually left or entered the business bank account. As many business owners will know, payments don't always happen right away.

Example Profit and Loss Statement for Tropical Dreams 

Month: June
Revenue	$15,000
Refunds and returns	$0
Net Revenue	$15,000
Cost of goods sold	$2,000
Gross profit	$13,000
Operating expenses
Salaries	$6,000
Mortgage	$1,000
Water	$500
Travel	$250
Advertising	$250
EBITDA	$5,000

Let's take a cut flower business called Tropical Dreams as an example. In the month of June, Tropical Dreams sold $5,000 worth of fresh-cut flowers to florist shops around Jacksonville, Florida and delivered the flowers. So, on an accrual basis, they made $5,000 in revenue for June, which appears on the profit and loss statement as net income or net revenue—irrespective of when the buyers actually paid them for the flowers.

The cost of goods sold, frequently abbreviated to COGS, refers to the cost of the materials that go into the end product. For Tropical Dreams' flowers, this includes seeds, compost, growing stakes, training wires, organic fertilizer, and pesticides. Subtracting the COGS from the month's revenue, we get a gross profit of $13,000.

Next, we need to subtract the operating expenses, which are indirect and/or discretionary costs. For Tropical Dreams, these costs include three salaries of $2,000 each, a monthly mortgage payment on the field of $1,000, an irrigation water bill of $500, $250 on fuel for flower deliveries, and $250 for advertising. Tropical Dreams does its own business bookkeeping, so that is not included in the operating expenses. However, if they outsourced their bookkeeping, that expense would be added here.

Finally, the operating expenses are subtracted from the gross profit to find the "earnings before interest, tax, and depreciation," shortened to EBITDA. This tells you how profitable a company is. If interest, tax, and depreciation were also taken out, that would leave the "net profit,” which is used to calculate the earnings per share.

What Your Profit and Loss Statement Tells You

Tropical Dreams' profit and loss statement indicates that their business is profitable overall. Each month, they are making $5,000 which, after tax payments, they can use to expand their operating activities, take on more employees, invest in the stock market, or sponsor local community-based projects. If the profit and loss statement indicated a loss, they would need to look at increasing their profit margins and reducing their operating costs until they turned a profit. Analyzing the monthly profit and loss statement is an important part of small business accounting.

Cash Flow Statement

Whereas a profit and loss statement tells you whether you're making money, a cash flow statement tells you whether you can pay your bills. As a measure of liquidity, a cash flow statement tracks cash inflows and cash outflows on a day-to-day basis and tells you your cash balance (how much money you have in your bank accounts, till, etc.) at any point in time.

Cash Accounting Method

Because a cash flow statement tells you how much cash you have right now, your cash flows must be recorded on a cash basis, i.e. when the money actually leaves or arrives in your bank account. If you pay your bills one month ahead, this means that you would record the payment in the month it is paid rather than the month in which it is due. Likewise, if a sale is settled one month after it occurs, you would record the deposit in the month it is paid.

Example Cash Flow Statement for Tropical Dreams

Month: June
Opening balance	$7,000
Incoming cash
May sales	$3,000
June sales	$10,000
Total incoming	$13,000
Outgoing cash
Salaries	$4,000
Purchases	$12,000
Mortgage	$1,000
Water bill	$250
Electricity	$500
Fuel	$250
Vehicle servicing	$500
Advertising	$500
Total outgoing	$19,000
Monthly balance	-$6,000
Closing balance	$1,000

In June, the company's cash flow was negative but they turned a profit. That's why it's so important to use a balance sheet as well as a profit and loss statement—neither one tells you the full story.

In this case, Tropical Dreams started out with an opening balance of $7,000. They were paid $3,000 in arrears for sales they made in May as well as $10,000 for June sales. As we know from the profit and loss statement, the company's revenue for June was actually $15,000, but some of their buyers pay one month behind, so the remaining $5,000 won't arrive in their bank account (and hence they won't have it there to spend) until July. If Tropical Dreams had received a vendor credit, such as a refund from returned goods or an overpayment, that would be included as incoming cash.

As far as cash outflow, we can see that they only paid $4,000 in salaries in June. That's because they had taken on a new employee that month and the salaries paid were for the month of May. Then, because the business was growing well and they had some cash in reserve, the business owner decided to invest $5,000 in solar panels to eliminate their electricity bill (which we can see was also paid for the previous month) and another $5,000 on shade cloth to prepare for the summer heat, in addition to the usual $2,000 in materials.

Furthermore, the company vehicle needed servicing, which was an additional expense, and they paid for two months of advertising (June-July) to get ahead on their bills. As a result of the additional expenses and purchases, the monthly balance ended up being negative. However, because they started the month with $7,000 cash available, the business owner knew that she had enough cash to reinvest in bill reduction and growth.

What Your Cash Flow Statement Tells You

The cash flow statement tells you how well you are managing money on a day-to-day basis. As we saw in the example above, negative cash flow may indicate that a company is growing. However, if the profit and loss statement shows a loss, a negative cash flow could mean that the company's business model is unsustainable and significant changes need to be made.

If the cash flow statement shows positive cash flow and the P&L statement shows a profit, that usually means that the business is well established and can turn a profit with the tools they currently have. However, for a startup, having a positive cash flow and an overall loss often indicates that the business took out a loan or that the business owner drew on their personal savings account to keep things afloat but that the actual revenue received wasn't enough to cover their costs. 

Why It's Important to Have Accurate Profit and Loss and Cash Flow Statements

Keeping track of your income and expenditure on both an accrual and cash basis is essential not only for calculating your tax payments but also for making sure you know where your money is coming from and where it's going, ensuring you can cover your bills, and knowing whether your business is sustainable over time. 

Accurate record-keeping is also necessary for attracting investors and taking out loans. The third party needs to see whether your business is a good investment and whether you'll be able to make consistent repayments if you take out a loan. In most cases, investors and creditors will want to see both types of income statements to get an accurate picture of your business's financial health.

When to Get Professional Help

Many startups begin by keeping track of their accounts receivable, accounts payable, and cash flow using spreadsheets in Excel. In this case, you would need separate spreadsheets for your cash flow statement vs. profit and loss. However, as your business grows, you might find it more practical to get QuickBooks training and log your cash inflows and cash outflows in QuickBooks, or to consider outsourced bookkeeping.

Whether you decide to do your own bookkeeping or have someone else do your bookkeeping for you, it's important to see a small business accountant on a regular basis to analyze your financial statements. Your accountant will be able to explain the different accounting methods (accrual basis vs. cash basis), identify places where you could improve your income and reduce your expenses, and help you with strategic tax planning to help you take full advantage of tax credits and deductions.

Knowing Where You Stand and How You Got There is Necessary for Growth

Now that you understand the difference between a cash flow statement vs. profit and loss statement, you'll recognize why both of these financial statements are important for getting a clear picture of the health of your business. In the short term, your cash flow is what keeps the lights on and allows you to buy the materials you need to keep trading. However, if you're not turning a profit, your business won’t be sustainable in the long term.

If you're just starting out, you’re looking to grow, or your small business is struggling to stay afloat, it's a good idea to consult with a professional accountant. They will be able to explain these financial statements in detail and give you the insights and tools you need to propel your business to a healthy financial future.