Cash & profit – Are they the same?
Cash & profit are two important financial concepts that are often confused, understanding the differences between cash & profit is essential in financial management & decision-making. Here are 5 key ways they are different:
1. Timing
Cash is the actual value of money a business has, usually held as bank balances & in cash. It represents actual inflows & outflows of money.
Profit is the difference between total sales & costs over the same period. Profit can be earned without any immediate cash paid in or out, it is revenue earned minus costs incurred, regardless of whether cash has been received or paid.
2. Non-cash Items
Profit includes non-cash items such as depreciation, which represent the allocation of the cost of fixed assets over their useful lives. These costs are deducted from income to calculate profit but do not impact cashflow, so don’t represent the movement of money.
3. Accounts receivable & payable
Cash is when money received & paid (including VAT), but Profit is when revenue & costs occur, i.e. on the day transaction takes place (Net of VAT).
Accounts receivable is money owed by customers who are given time to pay (or credit) & accounts payable is money owed to suppliers.
The timing of taxes paid or refunded, typically differs by 3 or more months.
The transactions determining the amounts to be received or paid affect profit immediately, but may not impact cash for a month or two, so there is potentially a big timing difference.
4. Investing and financing activities
Cash includes all cash flows from operating, investing, & financing activities, while profit focuses on operating activities.
Investing activities refer to cash flows from the purchase & sale of long-term assets or investments. Usually big one-off payments.
Financing activities such as, taking out loans, or making debt repayments, issuing, or repurchasing shares. Usually, big one-off monies received.
Profit focuses solely on operating activities & does not include cash flows & from financing activities, except for merely recognising any charges & interest paid or received.
5. Accrual accounting vs. cash accounting
Profit is typically calculated using accrual accounting, this means it recognises an income or cost on the day they are earned or incurred, regardless of when the cash is received or paid.
Accrual accounting provides a more accurate picture of the financial performance of a business.
Cash accounting, recognises revenue & costs when the actual cash is received or paid. Cash accounting provides an immediate view of the liquidity & cash position of a business but is unlikely to reflect profitability accurately.
Conclusion
In summary, cash represents the actual money a business receives, pays & possesses, while profit is a measure of financial performance. Both very important but very different measures you need to control, each requires its own system.