Why the Cash Position for the Business Does Not Equal the Profit for the Period.

Briefly explain why the cash position for the business does not equal the profit for the period.

It is important to understand that 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. Profit is determined by the difference between incomes earned and the expenses incurred in earning that income. Transactions of income and expenses take place not only on a cash basis but also on a credit basis.

The matching principle, also called accruals principle, is the concept that accounting transactions should be recorded in the period in which they actually occur rather than the period in which the cash flows related to them occur.

A standard company balance sheet has three parts: assets, liabilities and ownership equity. The main categories of assets are usually listed first, and typically in order of liquidity. Assets are followed by the liabilities. The difference between the assets and the liabilities is known as Equity and according to the accounting equation: Equity= Assets - Liabilities.

Another way to look at the same equation is Assets = Liabilities + Equity.

This equation shows how assets were financed: either by borrowing money (liability) or by using the owner's money (equity).

A business operating entirely in cash can measure its profits by withdrawing the entire bank balance at the end of the period. However, many businesses are not paid immediately; they have inventories of goods and equipment and own buildings. Businesses have assets and so they cannot immediately turn these into cash at the end of each period.

Let’s have a look at the company’s transactions as reported into the above Income Statement and Balance Sheet tables.

Transactions such as paying rent, salaries and advertising have a direct impact on cash position of...