Mba Maverick
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Why profit and cash flow are not the same thing? What, if any, is the relationship between both? Please be specific.
Cash and profit are not the same thing. Cash is more of a Need whereas Profit is something Desirable. Cash is often referred to as the King. And perhaps Profit should be referred to as the Queen ? Both the Cash Flow (CF) and the Profit together determine the successful operation of a business in the long run. The concept of Profit looks at income and expenses at a certain point in time, whereas Cash Flow is more dynamic and is concerned with the movement of money in and out of a business. More importantly, CF is connected to the time at which the movement of the money takes place.
The main difference between the two comes from the timing when an income is generated and an expense is made. If Income exceeds the Expense, this results in a Profit. However a company can be successful only if theres enough income to cover the expenses and keep the business functional as payments come due over a period of time. This is the most frequently encountered scenario wherein companies generally sell products to customers on credit basis rather than on cash basis. As per the credit terms, the product has been sold whereas the cash is not yet received until the next few months. As a result, the Sales figure appears within the Income Statement whereas the Cash Received is not entered in the CF Statement until the cash is actually received by the Seller.
A second example could be an instance of Prepaid Expenses wherein the expense has not yet been incurred as itd be done so during subsequent accounting periods. However the company needs to pay this amount upfront to avail of this service at a later stage (eg. Insurance or Rent). Such expenses are not accounted for in the calculation of Profit, rather they appear within the CF statement as Cash In or Out of the business depending on the Expense or Earning incurred.
Take the example of Non-Cash expenses which are used in the calculation of the companys Net Income. Non-Cash expenses do not involve any cash movements into and out of the organization. In the case of sale of fixed assets, a company can make either a profit or a loss. The CF statement records the entire proceeds from the sale of the asset but not the gain or loss which is actually shown on the Income Statement.