Difference Between Profit And Cash

June 1st, 2006 Comments off
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PROFIT

  • Profit is when the Income exceeds Expenses (Loss is when Income is lesser than Expenses).

  • Therefore, profit is the residual amount that remains after expenses have been deducted from income.

  • The profit shown in the Income Statement are based on the Accrual and Matching Concepts and not on cash basis. ( Refer to my article on matching and accrual concept )

 

CASH

Cash is basically cash on hand and demand deposits. Cash equivalents include short-term, highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value.

DIFFERENCE BETWEEN PROFIT AND CASH

  • A company makes a profit when its Incomes exceed its Expenses.
  • From the Income side, there are billings to customers that the company have not yet received cash for the goods or services rendered to these customers. In other words, the company is giving its customers credit. Only when the company receive the money from the customers, will that become cash in hand.
  • Similarly from the Expenses side, the company can be owing to the suppliers. The terms with them can be ranging from 7 days to 60 days. So, we don’t need to pay cash to buy their goods or services.

  • Don’t forget that there are some non-cash expenses items in the Income Statements like depreciation which is only an accounting method of allocating costs. (We have earlier used cash to pay for these fixed assets. It is only because of the matching concept that we need to allocate depreciation to the Income Statement.)

WHAT IS SO IMPORTANT BETWEEN PROFIT AND CASH?

  • The Company can be profitable meaning that its has income exceeding its expenses but it might not be liquid or cash rich because as earlier explained, the monies owing by its customers has not be received.

  • Sometimes, profitable companies can go under because it is not able to stay liquid due to the overextension of credit to their customers

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Financial Accounting

 
 

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