Tax Tip Thursday

Accounting Profit vs. Actual Cash Flow

Accounting profit and cash flow measure different aspects of a business’s financial performance. A business can report a profit while still experiencing a cash shortage, or it can generate positive cash flow during a period in which it reports a loss.

Accounting Profit

Accounting profit is revenue earned minus expenses incurred during an accounting period. Under accrual accounting, revenue is generally recorded when it is earned and expenses when they are incurred—not necessarily when cash is received or paid. Profit also includes non-cash items such as depreciation and may include sales for which customers have not yet paid.

Actual Cash Flow

Actual cash flow is the movement of cash into and out of the business. Cash inflows include customer collections, loan proceeds, and owner contributions. Cash outflows include supplier payments, payroll, taxes, loan principal payments, and purchases of equipment or other assets. Cash flow focuses on liquidity—whether the business has enough cash available to meet its obligations.

Why Profit and Cash Flow Differ

• Credit sales: Revenue may be recorded before the customer pays, increasing profit but not cash.
• Supplier credit: An expense may be recorded before it is paid, reducing profit before cash leaves the business.
• Capital purchases: Buying equipment uses cash immediately, while the cost is usually recognized gradually through depreciation.
• Loan transactions: Borrowing increases cash but is not revenue; repaying loan principal reduces cash but is not an expense.
• Inventory: Purchasing inventory uses cash, but the cost generally affects profit only when the inventory is sold.
• Non-cash expenses: Depreciation reduces accounting profit without requiring a current cash payment.
Tips for Managing Cash Flow
• Prepare a rolling cash-flow forecast: Project weekly cash receipts and payments for at least the next 13 weeks and update the forecast regularly.
• Invoice promptly and follow up: Send accurate invoices as soon as work is completed, set clear payment terms, and act quickly on overdue accounts.
• Manage payment timing: Use agreed supplier terms without paying unnecessarily early, while protecting important vendor relationships.
• Control inventory: Avoid tying up cash in slow-moving or excess stock, and monitor inventory turnover.
• Plan for taxes and major expenses: Set aside cash for income tax, sales tax, payroll remittances, equipment purchases, and seasonal obligations.
• Maintain a cash reserve: Build a buffer for unexpected costs, delayed customer payments, or temporary revenue declines.
• Match financing to the need: Use short-term credit for temporary working-capital gaps and longer-term financing for long-lived assets.
• Monitor key indicators: Review bank balances, accounts receivable aging, accounts payable, inventory levels, and forecast variances.
• Focus on profitable growth: Consider the cash required to support added sales; rapid growth can increase payroll, inventory, and receivables before customer cash arrives.

Key takeaway: Profit measures economic performance over a period, while cash flow measures the business’s ability to pay its bills. A healthy business should monitor and manage both.

We can help you learn how to manage your cash flow. Call us at 905 862 2727 to make an appointment or you can google The Mad Accountant and you can make an appointment through my website.  Make An Appointment today!

Disclaimer:

This article provides information of a general nature only. It is only current at the posting date. It is not updated and it may no longer be current. It does not provide legal or tax advice nor can it or should it be relied upon. All tax situations are specific to each individual. If you have specific tax questions you should book an appointment for a 1 on 1 consultation.