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Business Financial Accounting – Profit is NOT Cash!! How does that work?
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Published on Tuesday, 02 June 2015 23:12
Many business owners have profit on their reports, but don’t realise that Profit is NOT Cash! So how does that work they ask? Many wonder why they have no cash in the bank. If you have a lot cash sales, profit will usually correlate closely with the true cash situation in the bank. But if you invoice clients for goods and services, the timing of when customers pay has an effect on the cash the business actually has. For example not everyone pays on time, but if they did you would have regular cash flow, and receipt would only be delayed by the initial terms at the beginning eg 7 days, 30 days. Once those days have passed, if paid on time, it will mean a regular flow of money to cover your expenses.
What if clients are late paying? Then the debtors (accounts payable) on your balance sheet will grow (that is where the invoice “waits” for payment) until the client pays.
As an example, in our previous post explaining Profit and Loss, see HERE we gave an example of Profit and Loss resulting in $15,000 profit.
But what if you were only paid half of the sales at the end of the period (which is more close to reality – eg most clients pay you the next month or two…)
Then the accounting looks like this
Sales (invoices out) $100,000
But only paid (actual cash) $50,000
Which goes to bank (in assets)
Net Left due $50,000
Which sits in debtors/receivables (in assets)
Note - PROFIT would be same in accounting terms,
but CASH Profit would be -$35,000
That is - if you still had paid all your expense bills, you would have to find an extra $35,000 to pay them – see next
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