Cash versus Profit Training
Cash and profit are not the same. A company can be profitable and still run out of cash. And if it runs out of cash it may have to close its doors. This is a paradox that stumps a lot of people, including the entrepreneurs and company owners that it actually happens to.
There are three essential reasons why profit is not the same as cash:
- Revenue is booked at sale – revenue is recognized at the time of sale not when the bill is paid. We subtract our expenses from the revenue to determine profit but that is often no more than a promise. Customers have not yet paid for their product or service. The cash doesn’t show up for another 30-60 days depending on the terms and on if the customer actually pays you.
- Expenses are matched to revenue – Expenses such as annual payments are matched up to the revenue, such as paying for a year’s rent in advance. Most expenses are paid for later, when the vendors’ bills come due. The expenses on the income statement don’t reflect the cash going in and out during a specific time period.
- Capital expenditures don’t count against profit – capital expenditures don’t appear on the income statement when they occur, only the amount being depreciated is charged against revenue. Cash on the other hand goes out right away.
You may be thinking that in the long run cash flow will pretty much track net profit. Accounts receivable will be collected, accounts payable will be paid, and capital expenditures will be depreciated over time so eventually everything will match up. This is true to a degree but the difference between profit and cash can create all sorts of mischief in the meantime.
Financial statements training classes go through two sample companies and show the difference between cash and profit. Get a clearer picture of where your company stands with cash flow and profit and understand the difference.
Contact us to set up a live training class or sign up for our online financial statements training.