Cash Flow Positive: What It Is and Why It Isn’t Profitability

Seth David

Seth David

Chief Nerd and President at Nerd Enterprises, Inc.
Seth David is the chief nerd and President of Nerd Enterprises, Inc. which provides consulting and training services in Accounting and productivity based software. Consulting services range from basic bookkeeping to CFO-level services such as financial modeling.
Seth David

As a business owner, you’ll hear “cash is king” over and over again. But there’s a reason people say cash is king rather than profits. Why?

Let’s explore how cash flow positive is different than profitability, and why your business needs to know this.

When Can You Be Profitable but Not Cash Flow Positive?

Imagine I purchase a rental property for $1,500,000 and I put down 20%, or $300,000. That leaves me with a loan amount of $1,200,000. Let’s go ahead and assume a rate of 5%. So, with a 30-year mortgage (or 360 months), my monthly payment will come out to $6,441.86.

The property itself then becomes an asset on my balance sheet. The principal repayments on the loan are also on the balance sheet. They reduce a liability.

Of the following transaction, only the interest expense portion of the monthly payment will go on the profit and loss.

Now, once my property is purchased and everything is settled, I start renting the units. Let’s say I have four units in the building, and they are each renting for $3,500 each month.

To start, I’m able to rent out two of the four units.

This means I’d be making $7,000 in month one in revenue, while also paying $5,000 in interest and $1,441.86 in principal for my loan in month one. Check out an example interest schedule for a clearer picture here. The video above goes further into how you can copy this schedule and practice with a few different scenarios.

Now, let’s assume for the moment that the only other expense you had was a $1,000 utilities bill. If that’s the case, your profit for the month would be $1,000, but your cash flow would be -$441.86.

As you can see in a scenario like this, albeit oversimplified, you would be profitable—yet out of business—unless you increased the rental income. Even at max capacity, when you introduce other additional expenses, you would still probably be out of business over some period of time.

The best way to fix this problem would be to put a larger down payment on the property and reduce your monthly mortgage payments.

If you increased your down payment to 40% on the property, your monthly payment goes down to $4,831. This is likely to be much more manageable, but of course it required getting an extra $300,000 from somewhere.

This is why it’s important to understand your statement of cash flows. In this scenario, the profit and loss alone would look profitable, which might lead you to believe all was well. But if you hop on over to the statement of cash flows, you’d see your net income reduced by the principal payment on the mortgage to arrive at your actual cash flow. Now you can see that you’re in trouble.

When Can You Be Cash Flow Positive but Not Profitable?

On the other side of this, you can also have positive cash flow while operating at a loss. In this case, you can stay in business this way for as long as your funding sources last.

Startups are a great example of this. You can line up VC funding and then live off of that. You might have no revenue but plenty of expenses. The VC funding is not revenue, but it does go to increase the equity section of your balance sheet. If you are borrowing the money (not exchanging the funds for equity), then the funds go to increase a liability. Either way you are adding money to the balance sheet, and none of it affects the profit and loss.

Usually with VC funding, we figure the “burn rate.” How long will the money last before we need to either turn a profit, add more VC funding, or sell the company?

To figure the burn rate, we need to know the total cash flow, not just the expenses.

Cash is indeed king, and cash flow positive trumps profitability every time as you can always survive on positive cash flow but not necessarily on profitability alone.

Editorial Note: Any opinions, analyses, reviews or recommendations expressed in this article are those of the author’s alone, and have not been reviewed, approved, or otherwise endorsed by any of these entities.
Seth David

Seth David

Chief Nerd and President at Nerd Enterprises, Inc.
Seth David is the chief nerd and President of Nerd Enterprises, Inc. which provides consulting and training services in Accounting and productivity based software. Consulting services range from basic bookkeeping to CFO-level services such as financial modeling.
Seth David

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