Cash vs Profit
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Cash vs Profit
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. This is a paradox that confuses many people, including entrepreneurs and company owners.
There are three main reasons why profit is not the same as cash:
• Revenue is recognized at sale – Revenue is recorded when a sale is made, not when the bill is paid. We subtract expenses from revenue to calculate profit, but that is often just a promise. Customers haven’t paid for the product or service yet. The cash arrives 30-60 days later, depending on the terms and if the customer actually pays.
• Expenses are matched to revenue – Expenses, like annual payments, are matched with revenue. Most expenses are paid later when vendors’ bills are due. The expenses listed on the income statement don’t show the cash flow during a specific period.
• Capital expenditures don’t affect profit – Capital expenditures don’t appear in the income statement when they happen. Only the depreciated amount is deducted from revenue. However, cash is spent right away.
You might think that in the long run, cash flow will align with 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 partly true, but the difference between profit and cash can cause problems 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.
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