{"id":918,"date":"2019-01-17T17:56:07","date_gmt":"2019-01-17T17:56:07","guid":{"rendered":"https:\/\/www.excelsisaccounting.com\/blog\/?p=918"},"modified":"2019-01-17T17:56:08","modified_gmt":"2019-01-17T17:56:08","slug":"how-do-profits-and-cash-flow-differ","status":"publish","type":"post","link":"https:\/\/www.excelsisaccounting.com\/blog\/index.php\/2019\/01\/17\/how-do-profits-and-cash-flow-differ\/","title":{"rendered":"How do profits and cash flow differ?"},"content":{"rendered":"

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Working capital <\/p>\n

Profits are closely related to taxable income. Reported at the bottom of your company\u2019s income statement, they\u2019re essentially the result of revenue less the cost of goods sold and other operating expenses incurred in the accounting period. <\/p>\n

Generally Accepted Accounting Principles (GAAP) require companies to \u201cmatch\u201d costs and expenses to the period in which revenue is recognized. Under accrual-basis accounting, it doesn\u2019t necessarily matter when you receive payments from customers or when you pay expenses.<\/p>\n

For example, inventory sitting in a warehouse or retail store can\u2019t be deducted \u2014 even though it may have been long paid for (or financed). The expense hits your income statement only when an item is sold or used. Your inventory account contains many cash outflows that are waiting to be expensed. <\/p>\n

Other working capital accounts \u2014 such as accounts receivable, accrued expenses and trade payables \u2014 also represent a difference between the timing of cash flows. As your business grows and prepares for increasing future sales, you invest more in working capital, which temporarily depletes cash.<\/p>\n

The reverse also may be true. That is, a mature business may be a \u201ccash cow\u201d that generates ample cash, despite reporting lackluster profits. <\/p>\n

Capital expenditures, loan payments and more<\/p>\n

Working capital tells only part of the story. Your income statement also includes depreciation and amortization, which are noncash expenses. And it excludes changes in fixed assets, bank financing and owners\u2019 capital accounts, which affect cash that\u2019s on hand.<\/p>\n

To illustrate: Suppose your company uses tax depreciation schedules for book purposes. In 2018, you purchased new equipment to take advantage of the expanded Section 179 and bonus depreciation allowances. The entire purchase price of these items was deducted from profits in 2018. However, these purchases were financed with debt. So, actual cash outflows from the investments in 2018 were minimal.<\/p>\n

In 2019, your business will make loan payments that will reduce the amount of cash in the company\u2019s checking account. But your profits will be hit with only the interest expense (not the amount of principal that\u2019s being repaid). Plus, there will be no \u201cbasis\u201d left in the 2018 purchases to depreciate in 2019. These circumstances will artificially boost profits in 2019, without a proportionate increase in cash.<\/p>\n

Look beyond profits<\/p>\n

It\u2019s imperative for business owners and management to understand why profits and cash flow may not sync. If your profitable business has insufficient cash on hand to pay employees, suppliers, lenders or even the IRS, contact us to discuss ways to more effectively manage the cash flow cycle. <\/p>\n

\u00a9 2019
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