courses › Accounting

Profit Is Not Cash

level 16 course

Why a profitable month can still leave the bank account short.

In your head, jot if needed · no calculator why?

Opens at level 16.

Builds on: Cash In Is Not Always Revenue (not open yet) · Reading a P&L (not open yet)

the lesson

The idea, the techniques and a tip for each skill, right here. The Learn page adds worked examples for every skill and untimed practice.

Read the lesson · about 3 minutes

The idea

Profit and cash answer different questions. Under accrual accounting, revenue counts when the work is done and expenses count when they are used up, whatever day the money moves. Cash counts only money that actually came in or went out.

So a profitable month can leave the bank account short: the customer pays next month, but this month's bills are due now. Cash can also leave with no expense, as when you repay loan principal, pay the owner a distribution, or buy equipment. Depreciation works the other way: it cuts profit, and no cash moves.

Techniques

Keep two columns

Work, bills and payments happen in different months.

Profit column: work done this month, minus this month's expenses.
Cash column: only money that came in or went out.
A prepayment is cash in, but not profit until the work is done.

worked example

Example: A plant-care service finishes a $9,000 job this month; the customer pays next month. It pays $5,000 of this month's costs now. With no other transactions, what is this month's cash change? (Use a minus sign for a decrease.)

Profit: $9,000 − $5,000 = $4,000.
Cash in: $0. Cash out: $5,000.
Cash change: −$5,000.

Answer: −$5,000

Split a loan payment

A loan payment includes interest.

Interest is the cost of borrowing: an expense.
The rest is principal, which shrinks the debt.
Cash still falls by the whole payment.

worked example

Example: Of a $900 loan payment, $120 is interest. How much of the payment reduces the loan principal?

Principal: $900 − $120 = $780.
Only the $120 of interest is an expense.

Answer: $780

Days of sales tied up

Customers start paying later, and sales are steady.

Take the average credit sales per day.
Multiply by the extra days customers take.

worked example

Example: A tutoring service bills $400 a day, all on credit. Customers now pay 10 days later than before. Roughly how much extra cash is tied up in receivables?

Each extra day holds back one more day of sales.
$400 × 10 = $4,000.

Answer: $4,000

Tips by skill

TipThis month's cash change: Count only money that moved this month: customer payments in, bills paid out. Work done on credit adds no cash yet.
TipThis month's accrual profit: Work finished this month, paid or not, minus this month's expenses. Prepayments and loans are not profit.
TipInterest or principal?: Interest is the expense. The rest of the payment is principal, and it shrinks the debt.
TipCash tied up by slower collections: Multiply the credit sales per day by the extra days customers take to pay.
TipCash out, but not an expense: Cash out but no expense: principal, owner distributions, equipment, prepaid or old bills. Expense but no cash: depreciation, and bills or wages not yet paid.

Watch out for

Giving the profit as the cash change. Profit counts work done; cash counts money received.
Counting a customer's prepayment as this month's revenue. It is work you owe until it is done.
Treating the whole loan payment as an expense. Only the interest is.

skills · practice stats

From rounds of this course only: box, review and test-out answers are left out. Once a skill has 40 tries, it compares your first 20 tries with your last 20.

This month's cash change par 22 s not tried yet
worked example
A completed job earns $4,000. Its $2,000 expense is paid now, but the customer pays next month. With no other transactions, what is this month's cash change? (Use a minus sign for a decrease.)

Answer: -$2,000.00
1. Cash only moves when money moves: $0 in − $2,000 out = −$2,000.
2. This month's accrual profit is still $4,000 − $2,000 = $2,000.
This month's accrual profit par 23 s not tried yet
worked example
This month you finish $7,500 of work (the customer pays in 30 days), a customer prepays $1,000 for work you'll do next month, the bank lends you $16,500, and you pay $2,000 of this month's expenses. What is this month's accrual profit? (Use a minus sign for a loss.)

Answer: $5,500.00
1. Accrual profit counts revenue when it's earned: $7,500 earned − $2,000 of expenses = $5,500.
2. The prepayment is work you owe (a liability) until next month.
3. The loan is a debt, not revenue.
Interest or principal? par 10 s not tried yet
worked example
Of a $1,150 loan payment, $510 is interest. How much reduces the loan principal?

Answer: $640.00
1. Principal = payment − interest = $1,150 − $510 = $640.
2. Only the interest is an expense; the principal part just shrinks the debt. Cash still falls by the full $1,150.
Cash tied up by slower collections par 15 s not tried yet
worked example
Sales average $1,700 a day, all on credit. Customers now pay 15 days later than before. All else equal, how much extra cash is tied up in receivables?

Answer: $25,500.00
1. Each extra day of waiting holds back one more day of sales: $1,700 × 15 = $25,500.
2. It's a rough steady-state figure, not a full forecast.
Cash out, but not an expense par 15 s not tried yet
worked example
For a food truck, which of these reduces profit this month but uses no cash this month?
1. Paying $2,000 of this month's rent
2. Paying the owner a $1,000 distribution
3. Recording $250 of depreciation on equipment
4. Paying a $550 supplier bill that was recorded as an expense last month
Answer: Recording $250 of depreciation on equipment
1. Depreciation spreads the cost of equipment bought earlier. It lowers profit now, but no cash moves.
2. The other choices all use cash this month.

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