When going through a financial report, business owners take a look at cash flow and profit. As a bookkeeper, it is important to distinguish profit from cash flow.  Just because a business is making profit does not mean that cash flow is higher than the bottom-line profit.  Another surprising fact about cash flow and profit is that you can have a negative cash flow when earning a profit and a positive cash flow when you have a loss.

Cash flow refers to the difference between the actual cash used and the actual cash received. This means that the company receives and pays a certain amount of cash. Cash flow is a good guide for determining how your business is doing.

On the other hand, profit is revenue from sales of products and services. They can either be payment in the form of cash. The cash may or may have not been received yet and minus all expenses such as the expenses paid in cash, the expenses to be paid in cash at a much later date and the expenses and the expenses accounted for using other means.
It is necessary to find out whether your company is earning income by taking a look at the profit you are making.  Another way to know if your company is earning income is by tracking transactions including profits, sales and expenses.

Operating cash flow versus non-operating cash flow

Operating cash flow refers to the result of any cash activity taking place in a business operation regardless of whether the cash transaction generates earned revenue or incurs expenses when the transaction was made. A good example is when customers make advanced payments for their future purchases. With advanced payments, the company’s cash holding will have no effect on its current profitability. Another example is when a company choose to prepay future obligations. Prepaying future expenses reduce the company’s cash holdings without necessarily lowering the reported profitability when the cash transaction was made.

Not all cash flows come from the company’s operating activities as they can also be from financing and investing activities. When companies obtain funds or sell and investment from financing, an increase in cash positions will be reported. However, the financing proceeds and investment sale are not considered revenues. Using cash for repayments and investments are not considered expenses, thus they have no effect on the company’s profitability.

Business owners must assess short-term and long-term objectives to identify whether to focus on profits or cash. A company that has a strong current cash position should concentrate on driving more sales. If the company needs additional cash for covering short-term expenses, the profits need to take a backseat.

Published On: May 18th, 2016 / Categories: Bookkeeping / Tags: , , /

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