The Difference Between the Cash Flow and the Profit

It is vital to understand the cash position and the profit do not necessarily go together when running business. Profitable businesses still can go out of business because of cash flow problems. Cash flow is the movement of money in and out of the company’s bank account during a financial period. While profits are determined by the income earned with the expenses incurred in earning that income, which reveals the profit is simply the result of income minus expenses. However, transactions of income and expenses take place not only on a cash basis but also on a credit basis. Accounting, therefore, has to be used to adjust the timing difference in recording transactions to reflect the whole genuine picture.

An important principle that is particularly relevant to the interpretation of the distinction between the cash position and the profit is the matching principle. The matching principle, also called accruals principle, recognizes income when it is earned and recognizes expenses when they are incurred, not necessarily when money is received or paid out (a method called cash accounting), which allows better calculation and evaluation of actual profits and performance, and reduces discrepancy from timing mismatch between when costs are incurred and when revenue is realized. In the spreadsheet, the transaction of “company sells goods on credit for $7,000” illustrates the income, with the corresponding effect to the profit, by matching principle well. That means the double entry is an increase in asset receivables and an increase in income when the income is earned rather than it is received. This income is accrued by treating as income for profit purposes even though no cash payment has yet been made by the customer. Likewise, the transaction of “Company carries out advertising. The cost of $1,000 will be paid next month” revealed matching principle as well in interpreting expenses. The expense is accrued when advertising occurs for profit purpose though the money has...