Cash flow is not the same as profit – here’s why…(simple illustration)

Cash and profit are two different things in accounting.

Cash is the cash flow in and out of a business whereas, sales and expenses (in profit) can have non-cash transactions like depreciation, credit sales etc…

You can have really bad cash flow but show really high profits.

This is because of ‘invoicing’ and credit. For example, think of a large furniture business that offers customers 60-day payment days. So say you buy $50,000 worth of furniture now from them and then you pay them in 60 days time.

So… that furniture company will show in it’s accounting system:

Sales = $50,000

Account Receivable (this is the promise by the customer of money to be received by the company) = $50,000.

Profit is made up of Sales less Expenses. We have sales of $50,000 but no expenses recorded (because Accounts Receivable is shown as an asset). So profit is $50,000.

Also since there is no cash flow (because we haven’t received the cash from the customer but rather received a promise via a contract signed that they will pay us in 60 days time), cash flow = $0.

There’s an issue with this such as how about if the Furniture Company never get paid that $50,000 (bad debt) and then it also has bills to pay like electricity of $4,000. While the furniture company has a ‘promise’ of cash via a sale, it currently doesn’t have the cash in hand to pay it’s electricity bill if it’s due.

That’s one example of the difference between cash and profit, this idea of ‘promise’ of cash is recorded in profit and loss reports but not in cash flow.

Next: How to pay yourself from your business/from your company

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