Cash Flow vs Profit

Cash Flow vs Profit – What’s the difference?

It seems strange, but the easiest way to explain the difference between cash flow vs profit is to look at the balance sheets of a business. The movements between balance sheets is the key to understanding cash flow vs profit.

The table below shows the opening and closing balance sheets of a typical business, and in the final column shows the movement between the two balance sheets. The presentation has been simplified for the purpose of this explanation.

Beginning and Ending Balance Sheets

Cash Flow vs Profit: Beginning and Ending Balance Sheets
Balance sheet Beginning Ending Movement
Fixed Assets 20,000 55,000 35,000
Cash 3,000 7,500 4,500
Accounts receivable 5,000 9,000 4,000
Inventory 4,500 8,000 3,500
Accounts payable -6,000 -8,500 -2,500
Loans -12,000 -45,000 -33,000
Net assets 14,500 26,000 11,500
Capital 10,000 15,000 5,000
Retained earnings 4,500 11,000 6,500
Equity 14,500 26,000 11,500

The Balance Sheet Movements

If we look at the movement column, we can group together accounts receivable, inventory, and accounts payable, as these combined are called the working capital of the business.

Cash Flow vs Profit: Balance Sheet Movements
Balance sheet Movement Explanation
Fixed Assets 35,000 Fixed asset movement
Cash 4,500 Cash Flow
Working capital 5,000 Working capital movement
Loans -33,000 Loan movement
Net assets 11,500
Capital 5,000 New equity capital injected
Retained earnings 6,500 Profit for the year
Equity 11,500

Balance Sheet Movements Rearranged

If we simply rearrange the movements while maintaining the balance on both sides, we get the following.

Cash Flow vs Profit: Balance Sheet Rearranged
Balance sheet Movement Explanation
Cash 4,500 Cash Flow
4,500
Retained earnings 6,500 Profit for the year
Working capital -5,000 Working capital movement
Fixed Assets -35,000 Fixed asset movement
Loans 33,000 Loan movement
Capital 5,000 New equity capital injected
4,500

As both sides are equal (in this case 4,500) we can see that

Cash flow = Profit – Working capital funding – Fixed asset movement + Loan movement + New equity injected

Since we know the following:

  1. Fixed asset movement = Capital expenditure – Depreciation
  2. Loan movement = New loans + Interest – Loan repayments

We can rearrange the formula to give the following cash flow formula:

Cash flow = (Profit + depreciation + interest) – Working capital funding – Capital expenditure – Loan repayments + New equity + New loans

We now have a formula showing cash flow vs profit and we can see that:

  • Cash flow and profit are not the same
  • Profit is only one small element of cash flow.
  • A business can be profitable but still have a negative cash flow
  • If the profit margin is small, it is more important to control working capital (inventory, account receivables, and account payables)
  • Capital expenditure needs to be matched by new loans (or new equity) to avoid affecting cash flow.
  • As a business grows its working capital funding also grows (inventory and account receivables get higher), and cash flow can rapidly decline unless alternative sources of funding for expansion are found.
  • It is important to understand the balance sheet and balance sheet movements to understand and control cash flow.

Return to the Small Business Accounting Course

Cash Flow vs Profit November 6th, 2016Team

You May Also Like


Related pages


factoring receivables exampleaccounting ratios calculatorfifo method formulaexcel cash flow formulaperpetual annuityannuities present valueaccrued expenses entrywhat is prime cost in cost accountingear finance formuladiscounted cash flows excelsales discounts on income statementincome received in advance journal entrytrade creditors definitionfinancial statements for non profit organizations exampledefine accrued incomewhat is accounts payable ledgernegative irr excelfinancial projections excelassets turnover ratio interpretationexample of adjusting journal entrieshorizontal analysis of the income statementbookkeeping cash bookavailable for sale securities exampledeferred revenue expenditure written offdiscounted notes receivabledirect materials efficiency variancehow to solve bank reconciliation statementconsignment accounting journal entriesreceipt book template excellabor efficiency variance formulahow is markup calculatedwhat is stockholders equity in accountingcalculating margins in excelretained earning on balance sheetaccounting practice quizunearned rent revenuehow do you calculate capital employedcapital expenditure accounting entryreorder point safety stocklifo to fifo conversionweighted average inventory costing methodimprest basisgoodwill double entryreasons for material price varianceprepaid insurance assetvaluation allowance journal entrycalculate markup percentage formulapv of cash flows in exceldouble entry bookkeeping books free downloaddefine fob destinationpurchase to sales ratio formulapayroll cash advancesmall business excel accounting templateaccounting balance sheet calculatorabsorption costing accountingvertical analysis financial statementsaccounts receivable spreadsheet templateaverage account receivablespresent value of a growing annuityperiodic interest rate formulafuture value calculator excelvertical analysis of the income statementdeferrals accountingvariance analysis and standard costingpayback calculationperpetuity examplesfuture value annuity chartwhat does nett 30 days meanwhat is nrv in accountingroa equationprepaid and accrued expensessimple ledger templatestandard costing journal entries