Financial statements can be reported as both cash flow and accounting profit. Both are imperative to profit-making organizations and even individuals. Any entrepreneurial set up would aim to turn profitable as soon as possible, however cash flow is very important to sustain the setup.
Profit calculation in any business is both in terms of net profit and gross profit. While NET profit is the more accurate representation of the business situation, Cash flow is what keeps the business moving.
Accounting Profit vs Cash Flow
The main difference between cash flow and accounting profit is that Cash flow is incoming and outgoing of funds while accounting profit is a record of the transactions that take place with the company. Accounting profit does not account for whether the money has come in or not. It is a speculative calculation.
Comparison Table Between Accounting Profit and Cash Flow (in Tabular Form)
| Parameter of Comparison | Accounting Profit | Cash Flow |
|---|---|---|
| Definition | The difference between companies’ revenues and expenses is called the accounting profit. | The movement of cash due to activities such as operating, investing, and financing in a business is called the cash flow. |
| Elements | Includes all company expenses calculated under the GAAP. | It includes is a basic account of how much money in coming inside and is going outside the firm. |
| Nature | The standard representation of the financial health of a firm | The real representation of the financial health of the firm. |
| Time | It is based on obscure time records. | A lot of attention is paid to timing. |
| Relevance | It is based on accrual accounting methods; hence it is not a reliable representation. | It is a more factual representation of incoming and outgoing cash. |
| Capital Budgeting | Not concerned with profit accounting | capital budgeting is dependent on cash flow. |
| Method | Net income is reported based on revenues and expenses during the accounting period. | Net income is calculated using cash receipts and reimbursements. |
What is Accounting Profit?
The accounting profit for a company is the metric calculation used to indicate the financial health of the venture. The General Accepted Accounting Principle is used to combine relevant expenses like operating costs, taxes and interests, and depreciation.
The financial statement of a firm can be released in multiple ways. Usually, the accounting department puts together a balance sheet with revenues and expenses. Account profit is a method of bookkeeping to indicate the net profit a company can generate after deduction of expenses. Accounting profit is different from economic profit. Unlike economic profit, accounting profit only represents monetary expenses and revenues.
The general method for calculating accounting profit is to register an income statement, say a company sold 2000 handsets for a certain amount. The cost of the handset, also known as the cost of goods sold is subtracted from this income statement.
Then all operating costs are subtracted to derive the operating profit. From this amount, the accounting profit is derived by calculating non-operating expenses such as depreciation, amortization, interests, and taxes.
Accounting profit is not a full-proof method to calculate a company’s financial situation since it does not take into account implicit costs. Accounting profit calculation is done through the accrual method and is also called financial bookkeeping.
What is Cash Flow?
Cash flow is a system of accounting that estimates the financial health of a firm by keeping a track of the cash inflow and outflow. This method of accounting is somewhat the exact opposite of the accrual method. The method gauges upon the profitability of a venture by taking into account the revenue and expenses only when the transaction has occurred.
Unlike the system of accounting profit cash flow is not a speculative system of analysis hence it can be said that it is a better way to see if the numbers in a business are converting.
Many businesses seem to declare profitability however end up draining their resources due to the absence of cash flow. For a business to function well, revenue, profit, and cash flow should be collectively taken into account.
Even though the system of cash flow accounting seems to be full-proof, it is not very effective for ventures that function in a system of credit. Business transactions done in credit would not be accounted until the said payment is deposited in the bank account. To solve this problem a double-entry sheet must be maintained.
The ideal target for any venture would be to achieve positive cash flow and generate long term free cash flow. The cash flow system asses the timing and uncertainty of cash flow into a business. Financial reports usually comprise three types of cash flow, namely Investing cash flow, operating cash flow, and financial cash flow.
Ventures with a strong and flexible cash flow record are likely to attract more investors and avoid financial distress.
Main Differences Between Accounting Profit and Cash Flow
- Accounting profit is a system of financial reporting that considers the total revenue and operating expenses to estimate the profit for a firm, whereas the Cash flow system tracks the inflow and outflow of cash to account for profit in a firm.
- Accounting profit reports revenues as they are earned while Cash flow system reports income statement only after the cash is received.
- The accounting system is highly dependent on the GAAP principles, while the cash flow system often violets certain accounting principles.
- Net income is based on reported revenues and known expenses whereas, in the Cashflow system, profit is reported using cash receipts and cash disbursements.
- The Accounting method is independent of capital budgeting whereas, cash flow determines capital budgeting.
Conclusion
Business is highly dependent on financial accounting. There are multiple ways in which one can determine the financial health of a firm. Accounting profit is a common method in which the difference in revenue and expenses is reported to estimate the profit of a firm.
Cash flow is another financial method that accounts for a company’s health by checking the inflow and outflow of cash. The main difference between Accounting profit and cash flow is that in accounting profit earned revenue and expenses are reported immediately, while in the cash flow system the expenses and revenues are reported only after the cash transaction has occurred.
References
- http://www.joams.com/uploadfile/2015/0602/20150602115256681.pdf
- https://www.hbs.edu/faculty/Pages/item.aspx?num=7567