There are many people out there that believe that if you are Cash-Flow Positive you are Profitable, or even worse, there are others out there that think Cash-Flow Positive and Profit are the same.
Those people are wrong, and if you are one of those people then I’d like to point out that you’re not the only one who believes this and I’m glad you’re reading this post.
Cash-Flow is basically what the name says it is, it is the flow (movement) of cash (money) coming into (incomes) and going out of (expenses) of the business. Businesses are required to create a “Cash Flow Forecast” as part of their financial statement, and the forecast states the movement of cash through investing, financing (long-term financing and dividends) and operations (current assets and liabilities).
As a result this means that Cash-Flow is essential to the liquidity or solvency of the business. In other words, businesses need to keep a close eye on their Cash-Flow to ensure they can afford to make the payments to their creditors. If businesses correctly forecast they can anticipate periods where they won’t have enough cash in the business to pay their creditors which allows them to make decisions on purchases, as well as, provide the business with the ability to get an extended overdraft or loan to cover the period of negative cash flow.
Cash Flow Positive is where the businesses long-term cash inflows are exceeding its long-term cash outflows. Note: It is vitally important that you realise that just because a business is bringing in more cash it does not mean that is it profitable (and vice versa).
In order to help you understand this, I am going to use Twitter since this was part of the reason that led me to writing the post. This is because there have been reports all over the internet that Twitter is profitable. The likes of Bloomberg, Mashable, BusinessWeek, GigaOm etc all reported that Twitter was profitable, and yet all of them were wrong. Why are they wrong? Twitter isn’t actually profitable, they are cash-flow positive. Twitter have raised $155M in Venture Capital and yet because, Twitter is reportedly pulling in $25M/year from the content deals with Microsoft and Google respectively they’ve decided to claim Twitter is profitable.
Twitter will only become profitable when they have ‘repaid’ the $155M investment back to the venture capitalists and have excess money after the ‘repayment’ has been made. This is because, Profit is essentially Total Revenue minus Total Costs and if the businesses Total Revenue exceeds the Total Costs they are profitable and for Twitter they are essentially in debt of around $155 Million and when that amount is ‘repaid’ they will become profitable. Until then they are cash-flow positive.
However, it is likely that Twitter’s investment is not debt financing. Therefore, another example of this would be a manufacturing company who purchase equipment to produce goods. However, the firm is experiencing financial difficulty and cannot take out any further loans from banks (or other financial institutions) so as a result, they decide to sell half of their manufacturing equipment. As a result of this sale, the firm will be cash-flow positive due to the fact they have sold manufacturing equipment however, they will not make a profit on this as the items have been used and they will have sold them for liquidation prices.
I hope this helps you understand the difference between Profitability and being Cash-Flow Positive, and from an investment perspective it is important to note, as highlighted by the example above, that a business can be cash-flow positive yet not be profitable, which is why when investing you should analyze income statements and cash-flow statements and not one or the other.
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Isn’t venture capital equity financing and not debt financing? Twitter aren’t actually in debt 155M.
You seem to be confusing Return on Investment with Operating Profit.
Twitter is Profitable once it’s Income from Operations exceeds it’s costs including any amortized capital investments and depreciation.
How much is invested into Twitter or even borrowed has nothing to do with it’s profit until that money is spent is acconted for (if spent on Capital projects then that cost is spread out over the lifespan of the investment). Investment is only “paid back” in dividends (paid out if profits) or if the company is sold (or part of it at least like in an IPO).
So Twitter is likely Profitable today. We will see if it’s investors get any return (which they likely will get a great one).
Just a note, Twitter will have to pay a nice premium on the $155million invested so they need to pay off a greater debt.
John & Ron, I mentioned in the article that Twitters investment is likely to not be debt-financing which is why I included the other example of a manufacturing firm selling its equipment at liquidation prices.
Really enjoyed the site