Cash Flow v's Profit

Why cash flow is not profit….

Profit is the surplus after total costs have been deducted from total revenue, whereas cash is money at bank or in hand, readily available for use.

Profits are calculated in the ‘income statement’ whereas cash is shown in the cash flow forecast.

Cash is only recorded when money changes hands, that is, it will only be recorded in the statement once the business has 'actually' received money, rather than what it is 'promised' to receive.

For instance, if a business makes sales which are 10% on cash and 90% on credit, then the cash flow statement will only record the money received for the "10%" of sales and it will record the rest of the "90%" when it has 'actually' received this money.

On the other hand when we calculate profit, we will include the cash as well as credit sales, which means all of the sales made. Now this shows that the business is profitable but it will actually be short on cash.

Some other cases where profitable business can run out of cash are :
a: purchase of an fixed asset (through cash)
b: over-trading

Cash flow is vital in the short run and profit is vital in the long run.

Therefore, cash is important in the short run as it is needed to pay creditors and workers. Without sufficient cash, creditors (in extreme cases) can take you to the court and declare you bankrupt or insolvent in case of companies.

See this video.http://news.bbc.co.uk/1/hi/business/7874984.stm

Workers who will not be paid on time will be demotivated, resulting in poor productivity, high absenteeism and high labour turnover.

Profits are essential for the long term survival of the business, otherwise no institution would be interested to invest in a business which yields them low return on their capital investment.