Financial statements can be reported as both cash flow and accounting profit. Both are imperative to profit-making organizations and even individuals.
Any entrepreneurial setup would aim to turn profitable as soon as possible. However, cash flow is significant to sustain the structure.
Profit calculation in any business includes the net and gross profit. While NET profit is the more accurate representation of the business situation, Cash flow keeps the company moving.
- Accounting profit is the difference between revenue and expenses calculated Generally using Accepted Accounting Principles (GAAP).
- Cash flow is the movement of cash in and out of business.
- Accounting profit is based on accrual accounting, while cash flow is based on actual cash transactions.
Accounting Profit vs Cash Flow
The difference between cash flow and accounting profit is that Cash flow is incoming and outgoing funds. In contrast, accounting profit is a record of the transactions within the company. Accounting profit does not account for whether the money has come in. It is a theoretical calculation.
Want to save this article for later? Click the heart in the bottom right corner to save to your own articles box!
|Parameter of Comparison||Accounting Profit||Cash Flow|
|Definition||The difference between companies’ revenues and expenses is called the accounting profit.||Cash flow is the cash movement from operating, investing, and financing a business.|
|Elements||Includes all company expenses calculated under the GAAP.||It includes a basic account of how much money comes inside and outside the firm.|
|Nature||The standard representation of the financial health of a firm||The accurate 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 and 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 venture’s financial health. The General Accepted Accounting Principle combines 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 deducting 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. The accounting profit is derived from this amount 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 consider implicit costs. Accounting profit calculation is done through the accrual method called financial bookkeeping.
What is Cash Flow?
Cash flow is a system of accounting that estimates the financial health of a firm by keeping track of the cash inflow and outflow. This method of accounting is somewhat the exact opposite of the accrual method.
The method gauges 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 but 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 considered collectively.
Even though the system of cash flow accounting seems to be full-proof, it is not very practical for ventures that function in a credit system.
Business transactions done in credit would not be accounted for until the 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: Investing cash flow, operating cash flow, and financial cash flow.
Ventures with a strong and flexible cash flow record will likely 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 a firm’s profit. In contrast, the Cash flow system tracks the inflow and outflow of cash to account for profit in a firm.
- Accounting profit reports revenues as earned, while the Cash flow system reports income statements only after the cash is received.
- The accounting system is highly dependent on GAAP principles, while the cash flow system often violates 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 disbursements.
- The Accounting method is independent of capital budgeting, whereas cash flow determines capital budgeting.
I’ve put so much effort writing this blog post to provide value to you. It’ll be very helpful for me, if you consider sharing it on social media or with your friends/family. SHARING IS ♥️
Chara Yadav holds MBA in Finance. Her goal is to simplify finance-related topics. She has worked in finance for about 25 years. She has held multiple finance and banking classes for business schools and communities. Read more at her bio page.