WHY PROFIT DOES NOT EQUAL CASH
Why is profit not equal to cash coming in? Some differences such as loans received which do not impact the profit and loss statement are pretty obvious. Others may not be as obvious but you can break them down into three main areas:
- Revenue is booked at sale. In many cases a sale is recorded for accounting purposes in the profit and loss statement when a company delivers a product or service. In many cases, no cash has been exchanged at the time of sale since customers typically have a stated number of days to pay. So, since profit is partially determined by revenue, a component of that profit reflects a customer’s promise to pay. Cash ...view middle of the document...
It is very easy to reach a state where there is profit without cash. This is The Danger Zone.
It is also important to keep in mind that you may run into a situation where you have good cash flow without profit. Say you are a retailer and collect cash at sale. Your expenses may be paid to vendors at a later time which may lull an owner into a false sense of health. The cash flow statement may look fine as the business is growing, but if margins and expenses are poorly managed, the owner may find themselves in an unprofitable situation which cannot perpetuate a healthy business.
What Are the Differences Between Straight Line, Double-Declining Balance & Units of Production?
Depreciation is the allocation of an asset’s cost over its useful life. A company may choose from different methods of depreciation for financial reporting purposes. Straight line, double-declining balance and units of production are three such methods. Each method differs in the way it allocates an asset’s cost, which can affect your small business’ profit.
Purpose of Depreciation
Accrual-based accounting requires a business to match the expenses it incurs with the revenues it generates each accounting period. Because a long-term asset, such as a piece of equipment, contributes toward revenues over many accounting periods, a company spreads the asset’s cost over its useful life using depreciation. This creates a depreciation expense on the income statement each...