Profits vs. Cash Flow

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Often, cash-flow and profit are mistaken for one another by business owners. This mistake can lead to major problems when managing day-to-day operations and explains why often profitable companies experience cash shortages.

Working Capital

Profits are tied closely to taxable income. Profits are listed at the bottom of your company’s income statement, and reflect the result of revenue less the cost of goods sold and other operating expenses.

Generally Accepted Accounting Principles (GAAP) require that costs and expenses are matched to the period in which the revenue is recognized. When using accrual basis accounting the date of receiving payment or paying expenses does not necessarily matter.

For example, inventory that is being stored in a warehouse or on store shelves cannot be deducted, even though it has likely been paid for. These expenses show up on your income statement only once the item is sold or used. You inventory account provides many outflows of cash that will eventually be expensed.

Other working capital accounts including accounts receivable, accrued expenses and trade payables include differences between the timing of cash flows. When businesses grow and invest more in working capital to prepare for future sales cash is temporarily depleted.

Cash on Hand

Your income statement includes factors other than working capital that illustrate profit as well. Depreciation and amortization are non-cash expenses that are included on the statement. It is also significant that the income statement excludes fixed assets, bank financing and owner’s’ capital accounts; each factors that affect cash on hand.

For example:
In 2018 a company using tax depreciation schedules for book purposes purchases new equipment in order to take advantage of Section 179 and bonus depreciation values. This company has profits that will be hit only with the interest expenses, not the amount of principal being repaid. Also, there will be no “basis” left in the 2018 purchases to depreciate in 2019. These circumstances will artificially boost profits in 2019, without a proportionate cash increase.

Contact us

Understanding why profits and cash flow are not always in sync is important for business owners. Contact us, and we can look into instances where a profitable business lacks enough cash on hand to pay employees, suppliers, lenders, or even the IRS.

Contact us at 949-860-9902 or click here, and we will contact you.

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