Why cash isn’t the same as profit and “Cash is king”

We all know that even a highly profitable business can fail because it runs out of cash.

But, how are cash & profit related and how can they be such different things?

Profit does not equal cash… Let’s look at the numbers.

• There are only two places that any transaction can end up, from an accounting point of view – it either goes to the balance sheet, or to the profit and loss (P & L).
• Some transactions go to both because as every good accountant will tell you – there are always two sides to every transaction, the debit side and the credit side ⁽¹⁾.

This is known as double-entry bookkeeping.  For example, if you buy office supplies but you don’t pay cash (maybe you used a credit card), the expense goes to the profit and loss and you record the obligation to pay off your card as a liability, in the balance sheet. So, one side is in the P & L and one side is in the balance sheet.

And that is why cash isn’t the same as profit:

• Not all items that go to the P & L are cash; and similarly
• Not all cash items go to the P & L.

Here are some common examples that you might come across in your business:

• Some transactions will appear on your P&L and others will show up on your balance sheet – and the results can be very different for your EBIT or business valuation.
• A business can be ‘asset rich, but cash poor’ and a so-called ‘good business’ can fail by running out of cash.
• Understanding the numbers and the way that a transaction will appear in your accounts is important in helping your business achieve sustainable growth and ensuring you won’t run out of cash.

As always, it’s important to plan ahead and that includes planning your cash flow. No budget or plan is complete unless it also models your cash flow.  Demand to know about cash.

Cash truly is king.

If you’d like help to better manage your cash flow, call us now on 1300 656 141.

• Note that the sum of the debits must equal the sum of the credits
• The payment of income tax and dividends are appropriations of profit. Appropriations are beyond the scope of this article.

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Neil Parker

MANAGING DIRECTOR

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