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The difference between cash and profit

The difference between cash and profit

Cash and profit are not the same. A loss making company can survive as long as it has cash. A profitable company cannot survive without cash. In business, cash is king.

A profit occurs whenever revenue exceeds expenses within a period. However,

  • Not all expenses recorded in the profit and loss are cash costs – for example, depreciation and amortisation of goodwill are non cash costs
  • Not all expenses are recorded in the profit and loss account – for example, capital expenditure is recorded (i.e. capitalised) on the balance sheet

Furthermore, the profit and loss account is drawn up on an accruals basis with revenues being recorded when they are earned (i.e. the invoice date) and costs recorded when they are incurred. The actual receipts and payments of cash may be several weeks or months after the invoice dates depending on the terms of business negotiated with customers and suppliers. Similarly, corporation tax for the trading period does not usually become due for payment until 9 months after the period end date.

Cash flow is the life blood of all companies and it is important for every business to understand and actively manage its cash flows. A company’s cash flow is made up of three main constituents:

  • The cash flow from its operating activities – EBITDA less interest and taxes paid in the trading period plus the change in working capital during the trading period
  • The cash flow from its investing activities – investment in capital expenditure less the cash received from any asset disposals during the trading period
  • The cash flow from its financing activities – the change in equity and borrowings less interest and dividends paid during the trading period

Free cash flow is the cash that is free (i.e. available) to the investors who provide a company’s debt and equity finance. Free cash flow is the cash flow from its operating activities less the cash flow from its investing activities.

It is also important that a company understands and actively manages its working capital cash cycle. This is because company’s that go out of business usually do so because they run out of cash. Even a highly profitable company will go bust if it runs out of cash.

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