Profit is not cash flow, Financial Accounting

Profit is not cash flow:

Adequate cash is essential to keep business running. Inadequate cash increases the risk of not being able to meet current obligations as and when they arise which is dangerous to the company. There are many instances when businesses failed because of lack of cash flows even if they were profitable. Vice versa also hold good. Under accrual system of accounting net income (revenue less expenses) does not equate net positive cash flows. The difference is the timing of sale; expenses and profit do not coincide with their associated cash flows. Hence there is always a discrepancy between profit and net cash flow.

A statement of Cash Flows is an essential component of Financial Statements. As the profit and loss account and the balance sheet are prepared on accrual basis, the profits disclosed by the profit and loss account do not indicate the liquidity of the firm. A firm may be highly profitable but may find itself with hardly any cash or working capital to continue the operating cycle. On the contrary, a loss making firm may have sufficient cash flows. 

Posted Date: 8/29/2012 3:05:30 AM | Location : United States

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