Section 8 of 8
Profit is calculated on an accruals basis — revenues are matched to the period in which they are earned, and expenses to the period in which they are incurred, regardless of when cash moves.
Cash reflects actual money received and paid in a period.
A business can be profitable but cash-poor, or cash-rich but low-profit.
| Transaction | Effect on profit | Effect on cash/liquidity |
|---|---|---|
| Depreciation charge | Reduces profit (expense) | No cash outflow |
| Credit sales | Increases revenue and profit | No cash received yet |
| Credit purchases | Increases cost of sales, reduces profit | No cash paid yet |
| Accrued expenses | Increases expenses, reduces profit | No cash paid yet |
| Prepaid expenses | Reduces expenses, increases profit | Cash already paid in a prior period |
| Transaction | Effect on cash | Effect on profit |
|---|---|---|
| Buying inventory for cash | Reduces bank (liquidity falls) | No effect until goods are sold |
| Repaying a loan | Reduces bank | No effect on profit |
| Capital expenditure (buying a non-current asset for cash) | Reduces bank | Only the annual depreciation charge affects profit |
| Receiving a bank loan | Increases bank | No effect on profit |
Finished this chapter? Mark it complete to earn XP.
Finished reading? Mark this topic's notes complete to update your progress.