Introduction
Financial statements can be presented in cash flow and accounting profits. Both are crucial to profitable businesses and individuals. Every company will aim to be beneficial in the shortest time possible; however, cash flow is essential for the business's survival.
Profit calculation in every business is done in gross and net profits. Net profit is the most accurate depiction of the current business situation. Cash flow is what keeps the company going.
Accounting Profit vs. Cash Flow
The significant distinction between the two is that cash flow represents an incoming and outgoing flow of money while accounting profit records the transactions that occur within the business. Accounting profit doesn't account for whether the funds have been received. It's a speculation-based calculation.
Difference between Accounting Profit and Cash Flow in Tabular Form
| Parameters of Comparisons | Accounting Profit | Cash Flow |
| Definition | The difference in profits and expenses is referred to as" accounting profits. | The flow of cash that is through activities like operating, investing, or financing within a company is known as “cash flow. |
| Elements | All company expenses are that are calculated using GAAP. | It is a basic report of the amount of money that comes in and how much is being transferred outside of the company. |
| Nature | The standard way of assessing the health and financial condition of a business | The true indicator of the health of finances of the company. |
| Time | It is based on a variety of obscure time records. | A significant amount of attention is given to timing. |
| Relevance | It is based on the accrual method of accounting, which is why it's not a true representation. | It's a more precise depiction of outgoing and incoming cash. |
| Capital Budgeting | Don't worry about profits accounting | Capital budgeting is contingent upon cash flows. |
| Method | Net income is calculated based on the amount of revenue and expenditures within the time frame of the financial period. | The net income calculation is made by using money receipts as well as reimbursements. |
What is Accounting Profit?
The accounting profit of companies is the most critical calculation used to determine the company's financial performance. A General Acknowledged Accounting Principle is used to incorporate essential expenses such as operating costs, interest and taxes, and depreciation.
The financial statements of a business can be published in various ways. The accounting department typically prepares a balance sheet that includes expenses and revenue. Accounting profit is a method of bookkeeping that shows the amount of profit that a business can earn after deducting expenses. Accounting profit is distinct from economic profit. Contrary to economic profits, accounting profit is merely the monetary costs and revenues.
The standard method for accounting profit is to create an income statement. For instance, the company sold 2000 phones for an amount. The price of the handset, or the price of goods sold, is deducted from the income statement.
After that, all operating costs are subtracted to calculate an operating margin. From this, the accounting profit is determined by calculating non-operating costs like amortization, depreciation interest, taxes, and depreciation.
Accounting profit isn't an exact method of calculating a company's financial condition because it does not consider the implicit costs. The calculation of accounting profits is carried out by using the accrual method. It is also known as financial bookkeeping.
Types of Accounting Profit
Cash Profit
Cash profit for a firm is the amount of profit it has made in financial terms. In the accounting profit, the expenses are taken out of profits regardless of whether the costs were covered. Also, the accounting profit includes accrued expenses.
However, cash profits are merely the result of taking into account the difference between cash outflows and inflows of a company. The principle of cash profits is that when the cash outflows are more significant than its outflows, it's called cash profit.
Cash profits are crucial for companies for a variety of reasons. In the first place, when a company keeps producing accounting profit but cannot turn an income into cash and fails to make a profit, it won't be able to promptly meet its cash obligations. Thus, the company could have a problematic relationship and its supplier.
In addition, cash flow issues could make a company take on additional debt to finance its activities. In addition, rising deficits could affect a company. In addition, cash profits are essential as they can keep a company from being forced to liquidate.
Economic Profit
The financial success of an enterprise is determined by its accounting profits. This is because businesses can decide on their economic profit by subtracting their total implicit and implicit costs from yields. This means companies can calculate their economic profit by subtracting the indirect expenses from their accounting profits.
As previously mentioned, implicit expenses are the cost of opportunity for the business. Businesses can determine their price of options by considering different ways to use their resources. Implicit expenses are subjective since companies make their judgments when calculating them.
Economic profit is a necessary form of profit that companies can calculate their effectiveness. When calculating the opportunity cost associated with their resource, they can determine how effectively they currently use those resources to earn profit.
The financial profit can assist the management in making choices regarding the utilization of their resources. Investors and other stakeholders could use it to determine the company's economic viability and whether investing elsewhere would be better.
Taxable Profit
Taxable profits are different in comparison to cash and economic gains. Businesses have to calculate their taxes-deductible profits according to tax laws of specific states as opposed to accounting guidelines. While it is possible to deduct most of its expenses from its earnings in calculating its tax-deductible profits, certain expenses might not be eligible for deductions.
The tax law in the area where the company operates can specify what expenses can be deducted and which aren't. Businesses might also need to calculate certain costs, like depreciation, according to tax laws, not accounting regulations.
The taxable profits are essential when calculating the tax it will owe for the duration. This is because tax laws do not permit companies to calculate their tax using economic or accounting profits.
There are various reasons the tax laws prevent companies from deducting all kinds of expenses that they incur when they reach their tax-deductible profits. The shareholders and investors might not be informed of the tax-deductible earnings of the company as the profits are not an element of the disclosures required by a company.
What is Cash Flow?
The cash flow method is a type of accounting that evaluates a company's financial health by keeping a record of cash flows and outflows. This accounting method is, in a way, the opposite of that of an accrual system. The technique measures the efficiency of a venture by considering the costs and revenues only after the transaction is completed.
In contrast to the accounting system, profits cash flow is not a theoretical analysis; therefore, it is possible to say that it is a more reliable method to determine if the numbers of a company are growing.
Many businesses claim profits but then drain their resources because of the lack or lack of liquidity. For a company to operate effectively, profit, revenue, and cash flow must be holistically considered.
While the system for cash flow management appears to be 100% secure but it's not efficient for businesses that operate within a credit system. Credit transactions in the industry are not accounted for until the money is transferred to an account at a bank. To resolve this issue, the double-entry sheet needs to be kept.
The ultimate goal of any business is to create positive cash flow and create an ongoing free cash flow. The cash flow system evaluates the timing and the uncertainty of cash flow to the business.
Financial reports typically contain three kinds of cash flow: operating and financial. Ventures with solid flexibility in their cash flow track record are more likely to attract investors and avoid financial difficulties.
Types of Cash Flow
Operational cash flow
The cash flow generated by operations is known as "operating" cash. Operating activities are the day-to-day operations of a business, such as buying raw materials or selling. Cash flows result from cash sales and the collection of accounts payable.
This is essentially the source of revenue for the principal part of the business. Such as Apple Inc.'s income comes from selling its electronic devices. To earn these earnings, companies must perform processes like buying raw materials and inventory for manufacturing, paying employees, etc.
This is why cash outflows result from cash payments for raw materials such as taxes, salaries, etc. The drift of cash is deducted from cash inflows. The resultant amount is called operating cash flow, also known as net cash flow from operating activities.
Cash flow investment
The cash flow generated by investing activities is referred to as investment cash flow. Investment activities involve the buying and selling of long-term assets and other investments. Cash outflows are derived through the purchase of long-term assets and other investments comprising properties, plants, and equipment, intangible assets, short- and long-term investment in debt and equity issued by other companies, etc.
The cash flow resulting from the purchase of assets or securities exclusively for trading or as a company's primary business is not included in the investment cash flows. For instance, If you are an Indian exporter who hedges US dollars to limit the impact of the USD-INR exchange rate fluctuations in the current orders, then the cash flow resulting from this hedge is destined for operational cash flows and not investment cash flows.
Cash inflows can be categorized as the trading of non-trading security, plants, property and equipment, intangibles, and other long-term assets. The cash outflows then will be subtracted from cash inflows, and the resulting amount is the investment cash flow or net cash flow from investment activities.
Financing Cash Flow
The flow of money between a company's owners and investors and lenders are referred to as “financial cash flow. This kind of cash flow is a way to show how the company is organized and the financial results. Its strength from an ownership and investment standpoint is displaying the balance of cash going to investors and owners compared to the money that comes back into it.
This is important since even if a business isn't quite as solid from an operating cash flow standpoint, it could generate strong cash flows due to financing.
Depending on the form of the company and the type of ownership structure, businesses with a simple ownership structure might not have this kind of cash flow, and others that rely on investors and have more complicated ownership structures could have lots of it.
Main Differences Between Accounting Profit and Cash Flow
- Accounting Profit is a type of financial reporting which considers the total revenue and operational expenses to determine the profits of a business. In contrast, the Cash flow system monitors the outflow and inflow of cash to calculate a company's profit.
- Accounting profit reports revenue as earned, whereas the cash flow system calculates income statements only when the cash has been received.
- Accounting largely depends on GAAP principles; cash flow typically ignores certain accounting principles.
- Net income is determined by disclosed revenues and the number of expenses. In cash flow, the profit is calculated using the cash received and disbursed.
- The Accounting method is not a part of capital budgeting. However, the cash flow is what determines the capital budgeting.
Conclusion
Businesses are heavily dependent on accounting for financials. One can evaluate how financially healthy a company is in various ways. Accounting profit is one standard method by which the gap in expenses and revenue is calculated to determine the earnings of a business.
Cash flow is yet another method of accounting for the health of a business by monitoring the flow and outflow of cash. The primary difference between accounting cash flow and profit is that earned revenues and expenses are reported instantly; however, when using the cash flow system, income and expenses are notified when the cash transaction occurs.
References
- https://online.hbs.edu/blog/post/cash-flow-vs-profit
- https://www.wikiaccounting.com/?s=cash+flow+types
