Finance and Bookkeeping - Session 05

Profit and Cash

Explain why reported profit and bank cash change by different amounts. Build a simple bridge between the two and identify the records needed to explain the company's cash movement.

The MSP finance task

The October 1-6 export reports $109,258.35 of net income, yet cash is $51,804.90 below September's balance. Billing, collections, card payments, and incomplete cost posting all need investigation. Profit alone cannot explain how money moved.

Profit and bank cash

Profit measures recorded earnings after expenses. Cash measures money held. Accrual recording and payment dates can differ.

Operating balance changes

Unpaid invoices increase receivables and reduce collections relative to profit. Unpaid bills increase payables and defer cash payments. Check adjustments before interpreting balance changes.

Depreciation and equipment

Depreciation can reduce profit without a new payment. A capitalized equipment purchase uses cash before its full cost appears as expense.

Borrowing and owners

Loan receipts add cash and debt. Principal repayments use cash and reduce debt. Owner contributions and distributions generally affect equity under the entity's rules.

The cash-flow statement

Operating, investing, and financing sections explain cash movement. Opening cash plus net movement should reconcile to closing cash under a consistent cash definition.

The practice operating bridge

$5,000 net income + $500 depreciation - $2,000 receivable increase + $1,000 payable increase = $4,500 operating cash flow.

The practice closing cash

$4,500 operating inflow - $3,000 equipment - $800 principal - $700 distribution = $0 cash movement. Opening and closing cash both equal $20,000.

The October investigation

Cash fell $51,804.90 while the partial report shows profit. Obtain dated cash activity and completeness checks. Keep unresolved differences visible.

A business records $5,000 of accrual profit while receivables increase $2,000 from unpaid invoices. Ignoring other changes, what operating cash amount follows?

  1. $7,000
  2. $5,000
  3. $2,000
  4. $3,000

Depreciation of $500 is included in net income. Why is it added back in a simple indirect cash bridge?

  1. It used no new cash in the period
  2. It was incorrectly recorded as an expense
  3. It increases the equipment's market value
  4. It cancels the need to replace equipment

An MSP receives $10,000 of loan principal. What happens at receipt?

  1. Service revenue and profit rise $10,000
  2. Cash and a borrowing liability rise $10,000
  3. Receivables and payroll expense rise $10,000
  4. Equity rises because no repayment is required

Key terms

Accrual accounting
Recording financial activity when it is earned or incurred rather than only when money changes hands.
Cash bridge
An explanation connecting reported profit with the change in cash.
Depreciation
Allocating the recorded cost of a qualifying asset over its useful life under the accounting policy.
Capital expenditure
Spending on an asset recorded for use over more than one period under the capitalization policy.

Three points to remember

  1. Profit and cash differ because of timing, noncash items, and funding.
  2. Balance changes need explanations before becoming cash assumptions.
  3. Actual receipts and payments support a company cash investigation.