Businesses Should Not Mistake Profit for Cash Flow

 

Profit, Cash Flow pic

Profit, Cash Flow
Image: investopedia.com

The recipient of an MBA from St. Louis University, Frank L. Zerjav Sr., CPA, is the founder and CEO of Advisory Group Associates’ Tax & Advisory firms. From his CPA office in the Westport area of St. Louis County, Mo. Frank Zerjav advises clients on the management of income and cash flow.

The two terms are common in financial discussions, but they do not mean the same thing, and substituting one term for the other can cause a great deal of confusion. The reason is the accrual system of accounting.

The accrual system requires income and expenses to be accounted for when they are incurred, and that is not necessarily when the cash was actually received or paid. For example, on an income statement, credit sales are used to calculate profit, even when no cash has been received for the sales. For an item such as prepaid rent, when a business pays rent in advance, it does not include the prepaid rent in the income statement. In this case, the expense has not yet been incurred, even though the cash has left the business.

Because of these types of differences, a business can post huge profits while struggling with the necessary cash flow to pay for daily operation. Cash flow management focuses purely on actual cash moving in and out of the business and is necessary to avoid problems. Businesses must always distinguish between reported profits and actual cash in hand.

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