The Difference Between Profit And Cash Flow

By on May 13, 2018

Because cash flow is such an important term in real estate, many newer landlords actually chase a positive cash flow over profits.

And sometimes, people assume that when it comes to real estate, profit and cash flow mean the same thing. Positive cash flow would refer to profit, and negative cash flow would refer to losses.

In the big scheme of things, grouping both under the same umbrella can help make acquisition decisions easier.

But when it’s time to look deeper into investment viability, there is no doubt that profit and cash flow are very different animals. And they should be treated differently when conducting an assessment.

The key factor that makes them different is taxes.

Profits are taxable. While cash flow is a statement that shows the money coming in and going out of the company accounts.

For example, the repaid portion of a mortgage that is principal decreases cash flow as it is not deductible. The same cannot be said of the interest on mortgage.

And since we are giving examples, just take note that depreciation is usually the single most cash inflow item that will improve your cash position in the balance sheet.

See the difference

Let’s say for example, you have a rental property generating a positive cash flow of $50 a monthly after all outflow, and experiencing a tax-based net loss of $500.

This would result in your not only getting a $50 cash surplus each month, but would also enable you to claim a $500 tax loss too.

This is one of the factors of real estate when veteran investors talk about tax benefits.

Especially in the world of real estate, cash flow and profit must not be confused.

Cash inflow and outflow are basically terms to describe cash coming in and going out of the business. Profits can be highly dependent on variables such as deductible non-cash expenses and nondeductible payments.

If we go back to the example above and work out the annual figures, we get $600 positive cash flow and $6000 in losses for the financial year.

As you can see, they are not the same at all.

Also take note that this example is for illustrative purposes only. A loss is not something to brag about.

The example is just to show the difference between profit and cash flow.

Why use them?

You might now be scratching your head and ask why compare the 2 in the first place?

It is so that you can make proper evaluation of investment and rental property in order to make a calculated decision on whether to buy or not.

It goes without saying that everything being equal, if you are choosing between 2 properties with similar losses for the year, the one with the higher cash flow should trump the other in terms of investment attractiveness.

At this juncture, take note that for the purpose of tax planning, losses are actually good.

Yet if a rental property with inherited tenants is already suffering from negative cash flow, it does not necessarily make it a bad purchase.

As real estate values tend to appreciate over time, if a negative cash flow property is experiencing strong value growth, it might be more than worthwhile to keep it in your portfolio.

The losses or cash ouflow your will experience can very well be offset by value appreciation. Even if you have no intention to make capital gains from a sale, the beefed up home equity can be very useful when you need more liquidity.

The ideal scenario

From an investor standpoint, it would of course be ideal if you can get the best of both worlds.

Who wouldn’t want a rental house that is generating positive cash flow after all expenses, and provide tax benefits via legitimate accounting losses?

On the one hand, you obtain more cash to work with in daily operation. On the other, losses accumulated can become a substantial rebate on tax liabilities.

And you should be able to multiply these benefits by repeating your investments that meet the same criteria.

As a final footnote, do be reminded that losses are considered good in this argument when we are discussing tax planning matters.

You do want your investments to actually make you money by being profitable.

Learning the difference between profit and cash flow should help you develop a sharper eye for attractive investment opportunities.



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