Cash flow: Difference between cash and profit

The idea

Cash is the money a business has available to spend now, while profit is the surplus of revenue over total costs over a period. They differ because profit is calculated when sales are made, but cash arrives only when customers pay. A business can be profitable but short of cash if it sells on credit, holds unsold stock, or buys assets. Conversely, a business can have cash but make a loss if it receives a loan or sells an asset. Cash flow records actual receipts and payments; profit and loss records income earned and expenses incurred, including non-cash items such as depreciation. Understanding the difference helps explain why a profitable firm may still fail if it cannot pay bills on time.

What earns the marks

• Defines cash as money available to spend and profit as revenue minus total costs over a period.
• Explains that profit is recorded when a sale is made, whereas cash is received later if credit terms are offered.
• Gives an example of a profitable business with a cash shortage, such as selling on credit or building up stock.
• Gives an example of a business with cash but low or negative profit, such as receiving a loan or selling an asset.
• Distinguishes cash flow from profit and loss, noting that profit includes non-cash items such as depreciation.
• Explains why cash shortages can cause business failure even when the business is profitable.

Common mistakes and how to put them right

• Treating cash and profit as the same thing.

  Put it right: Profit is earned, cash is received; timing differences mean a profitable business can have a cash shortfall.

• Ignoring non-cash expenses: a student may exclude depreciation from profit calculations.

  Put it right: Depreciation reduces profit but does not involve cash leaving the business in that period.

• Assuming a cash receipt is profit.

  Put it right: A loan increases cash but is a liability, not income, so it does not increase profit.

• Confusing the timing of transactions.

  Put it right: Record the sale as revenue when made, but cash only when the customer pays.

Exam tips

• Use clear definitions at the start of your answer to show you know the difference between cash and profit.
• Apply the difference to the case: refer to specific figures or events, such as a credit sale or loan, to illustrate your point.
• When explaining why a profitable business can fail, link the cash shortage to inability to pay wages, suppliers or loan repayments on time.
• Avoid saying 'profit is money in the bank'; instead say profit is revenue minus costs, and cash is the money available to spend.