Every business organisation operates to earn some profit. Only a profitable organisation can survive and grow. However, profit is not the only element that determines the financial health of the organisation. Rather, a business must have sufficient amount of funds to run the basic operations and to meet its financial obligations. The quantum of funds available with the business are determined using the cash flow statement. The total cash flows is the difference between the total cash inflows minus total cash outflows. Whereas profit is determined by deducting all the business expenses from the revenues or income generated during the course of business. The cash flows of the company are ascertained by giving the time value of money a due consideration. However, the profits are not calculated after taking into account the time value of money. Cash flows covers only those in which there is an actual flow of cash occurs whereas profit does not only cover the transactions that involves cash movement. Even the non- cash items like depreciation are included in the calculation of profits of the business. Depreciation is an item of expense which is taken to profit and loss account. It is charged for the mere purpose of fair presentation and there is no such cash flow involved in this type of activities and hence they do not form part of cash flow statement of the firm. There are numerous ways of calculating profits of the company and profitability can be defined from several dimensions. But the cash flows are determined only by using a single method i.e. by one method of deducting all cash outflows from the cash inflows (Thomason, 2017). Profits of the company are calculated on the basis of accrual concept where the actual receipt and payment of cash is not considered rather transactions are entered in the books of accounts as and when they occur (Hanlon, 2005). This practice leads to differences in the profits of the company and the quantum of available cash with it. From the above facts, it can be concluded that cash flows provides wider view of business and its viability whereas profits does not offers the wider picture of business as it a close concept and not as broad as the concept of cash flows.
Therefore, to understand the ultimate performance of the business managers must consider both the parameters. Ignorance of any of these concepts may cause the business significant losses or it may cause other type of disturbance to the operations of the business. Though both the parameters are financial but yet both are necessary in the assessment of company’s financial position (Barth, Cram & Nelson, 2001). On one side, cash flows represents the overall financial health of the business, the profits represents the net earnings made by the business, on the other hand. In order to make any economic decision, the managers are necessarily required to analyse the difference between the profit figures of the company and its final cash position. The reasons for the differences among the two must be emphasised so that they may gain better understanding of company’s financial standing (Peavler, 2017). A company may seem to have ample of profit from the sales and other transaction but it may find itself short of funds even after making high profits. This cash crunch occurs when the company is involved in the practices of making credit sales. Under such circumstances the sales are generated rapidly due to higher demands, increasing the profits of the business but there is no sufficient flow of cash in the business. The insufficiency of funds forces the company to borrow the required amount of funds from the market. The cost of borrowing the required funds may cause incurrence of huge expenses leading the business towards making losses as it gets difficult for the business to recover such cost of borrowing from the sales revenue. At times, business managers finds their business in the situation where they possess enough of cash funds from several sources such as gifts, loans and borrowings, inheritance etc. but due to various factors such as extreme completion, changes in the tastes and preferences of the customers and various other environmental factors, the business is not capable to generate sales or profitability. In such situations it is important for the managers to understand the reasons of mismatching of profits and cash flows of the business so as to take appropriate decisions for the business.
References
Barth, M. E., Cram, D. P., & Nelson, K. K. (2001). Accruals and the prediction of future cash flows. The accounting review, 76(1), 27-58.
Hanlon, M. (2005). The persistence and pricing of earnings, accruals, and cash flows when firms have large book-tax differences. The accounting review, 80(1), 137-166.
Peavler, R. (2017). Business Finance, accessed on 15-12-2017. Retrieved from https://www.thebalance.com/are-a-firm-s-cash-flow-and-profit-different-393585
Thomason, K. (2017). Bizfluent. What Are the Differences Between Accounting Profit & Cash Flow? Accessed on 15-12-2017. Retrieved from < https://bizfluent.com/info-8543790-differences-accounting-profit-cash-flow.html>
