Bookkeeping and Accounting All-in-One For Dummies (UK Edition) by unknow

Author:unknow
Language: eng
Format: epub
ISBN: 9781119026617
Publisher: Wiley
Published: 2015-04-27T00:00:00+00:00

Adding net profit and depreciation to determine cash flow from profit is mixing apples and oranges. The business didn’t realise a £1.6 million cash increase from its £1.6 million net profit. The total of the increases of its debtors, stock and prepaid expenses is £1.92 million (refer to Figure 3-1), which wipes out the net profit amount and leaves the business with a cash balance hole of £320,000. This cash deficit is offset by the £220,000 increase in liabilities (explained later), leaving a £100,000 net profit deficit as far as cash flow is concerned. Depreciation recovery increased cash flow by £1.2 million. So the final cash flow from profit equals £1.1 million. But you’d never know this if you simply added depreciation expense to net profit for the period.

The managers didn’t have to go outside the business for the £1.1 million cash increase generated from its profit for the year. Cash flow from profit is an internal source of money generated by the business itself, in contrast to external money that the business raises from lenders and owners. A business doesn’t have to find sources of external money if its internal cash flow from profit is sufficient to provide for its growth.

In passing, we should mention that a business could have a negative cash flow from profit for a year – meaning that despite posting a net profit for the period, the changes in the company’s assets and liabilities caused its cash balance to decrease. In reverse, a business could report a bottom line loss in its Profit and Loss statement yet have a positive cash flow from its operating activities: the positive contribution from depreciation expense plus decreases in its debtors and stock could amount to more than the amount of loss. More commonly, a loss leads to negative cash flow or very little positive cash flow.

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