Profit, as indicated on the income statement, is different from net cash, as indicated on the cash flow statement.

Why is this the case?

There are three crucial justifications:

Sales are when revenue is booked.

Every time a business delivers a good or service, a sale is recorded. Delivering brochures to a customer for $1,500 results in Ace Printing Company recording revenue of $1,500; theoretically, Ace Printing Company may earn a profit based on deducting costs and expenses from that revenue. However, no money has been exchanged because Ace’s customers normally have at least 30 days to pay. Profit always reflects the commitments made by clients to pay as it all begins with revenue. Contrarily, cash flow always represents monetary transactions.

Revenue generates profit, whereas cash flow always reflects cash transactions.

Revenue and expenses are matched.

The income statement’s goal is to total up all the expenditures and expenses related to producing revenue during a specific time period. Those costs, however, could not be the ones that were really covered at that time. Some may have received payment sooner. Some of it will be paid once the vendors’ invoices are due. As a result, the income statement’s expenses do not accurately reflect cash outflow. However, the cash flow statement always tracks the amount of money coming in and going out during a specific time period.

Capital costs are not deducted from profits.

When a capital expenditure is made, only the depreciation is charged against revenue; the capital expenditure does not appear on the income statement. Therefore, a business can purchase computers, trucks, machinery, and other items with the knowledge that the expense won’t be recorded in full until each item has reached the end of its useful life. Of course, money is another matter: All of those things are frequently paid for before they have fully depreciated, and the cash that was needed to do so will be shown in the cash flow statement.

The gap between profit and cash can cause all kinds of trouble in the interim, especially for a growing business.

The fact that one significant client pays its bills very slowly or that one significant vendor needs upfront payment may be something they will have to deal with. Even while none of these significantly effect profitability, they can all have a disastrous impact on an entrepreneur’s cash flow.

You should comprehend the cash flow statement for three main reasons. The first benefit is that it will assist you in understanding the current situation, the direction the company is taking, and the probable priorities of top management.

You also have an impact on money. Instead than concentrating on both profit and cash, most managers place their attention solely on profit. Of fact, they often just have an impact on operating cash flow, but that is still one of the most crucial metrics available.

Third, as opposed to managers who solely concentrate on the income statement, those who have a solid understanding of cash flow are more likely to be given greater responsibilities and, consequently, to grow more quickly. You may approach someone in finance and say, “I notice our DSO [days sales outstanding] has been headed in the wrong direction over the last few months; how can I help turn that around?” Alternately, you may study the principles of lean enterprise, which emphasizes (among other things) keeping inventories to a minimum. Huge sums of money are liberated when a manager guides a business toward being lean.

When possible, do you postpone paying bills? When buying something, do you take cash flow into account? This is not to argue that delaying spending is always a good idea, but rather that it is a good idea to consider the cash impact of your decision before making it.

Don’t limit yourself to cash flow. Consider other aspects of your business as well, such as how satisfied your customers are with your service, how well-connected they are to your salespeople, and how accurate your invoices are. These aspects all contribute to how customers perceive your company and, in turn, indirectly affect how quickly they will pay their bills. Customers that are dissatisfied are not known for paying quickly; instead, they prefer to wait until any disagreement is settled.

Unaware of this? Together with profitability and shareholder equity, cash flow is a crucial sign of a business’s financial stability. It completes the triad’s chain.