The difference between accounting profit and cash profit
In the business world, managers and business owners face challenges in accurately understanding their financial results, especially when comparing accounting profits with cash flows. It is often assumed that accounting profit reflects the company's liquidity, while the reality is more complex. Therefore, it is essential to understand the difference between accounting profit and cash profit and their impact on management decisions.
First: What is accounting profit?
Accounting profit is the net income that appears in the company's financial statements after deducting all expenses from revenues during a specific financial period, according to generally accepted accounting principles (GAAP or IFRS).
Characteristics of accounting profit:
It relies on accrual accounting, meaning revenues and expenses are recorded when they are earned or incurred, not when cash is actually received or paid.
It includes depreciation, amortization, deferred costs, and provisions.
It is used to determine the financial performance of the company according to laws and international standards.
Second: What is cash profit?
Cash profit is the actual profit generated from the company's operating activities at the cash flow level, meaning the money that actually came in or went out of the treasury during a specific time period.
Characteristics of cash profit:
It focuses on available liquidity, not just theoretical profits.
It excludes non-cash items such as depreciation, provisions, or doubtful debts.
It is a critical indicator of the company's ability to meet its short-term obligations and finance its daily operations.
Third: The main differences between accounting profit and cash profit
| Element | Accounting profit | Cash profit |
|---|---|---|
| Basis | Accrual accounting | Actual cash flows |
| Impact of depreciation | Includes depreciation and amortization | Does not include depreciation because it is non-cash |
| Provisions and doubtful debts | They are deducted | Do not affect cash profit until they are paid or collected |
| Focus | Overall financial performance | Liquidity and ability to finance daily operations |
| Objective | Assessing profitability according to accounting standards | Assessing the ability to meet obligations and achieve positive cash flow |
Fourth: Why do they differ in practice?
Timing of revenue and expense recognition: revenue is recognized when earned, but cash may not be received yet.
Non-cash items: such as depreciation and provisions that reduce accounting profit but do not affect available cash.
Delays in payments and collections: customers may pay late, and suppliers may offer long payment terms, creating differences between the two profits.
Fifth: The importance of understanding the difference for management decision-making
Liquidity planning: relying solely on accounting profit may give a misleading picture of liquidity, leading to sudden financial crises.
Investment and financing: decisions related to expansion or investment must consider cash profit to ensure the company's ability to finance projects.
Evaluating true performance: cash profit reflects management's ability to manage cash flows and achieve financial sustainability.
Sixth: How to link accounting profit and cash profit
Starting from net accounting profit.
Adding non-cash items such as depreciation and amortization.
Adjusting for differences resulting from changes in accounts receivable, payable, and inventory.
The result is cash flow from operating activities, which represents true cash profit.