One area that often causes confusion is the difference between a businesses profit, shown on the profit & loss statement and what is referred to as its cashflow.
Profit, shown on the profit and loss statement, is a calculation of how much money has been made from a business’s activity each year. It is calculated as total income, minus costs (including costs of goods sold or direct costs, and other operating expenses, such as rent, wages etc.). This gives a business an indication of how it is performing in terms of profitability, or how much of their revenue is remaining after all costs incurred in generating that revenue are accounted for.
Profit can be calculated on a cash basis (cash received, minus cash spent), or an accruals basis (invoices issued minus invoices incurred), which is the more common approach. An accruals accounting basis means that a profit & loss statement can include revenue for which cash has not been received within the same period, and costs where the cash has not actually been spent in that same period. For example, if an invoice is issued to a customer on June 30th 2022, with 30 day payment terms, that invoices revenue will be included in that years profit & loss, even though the cash from the customer is possibly not received until the following 2023 financial year. Conversely a business may receive a large invoice from a supplier on June 30th 2022 which they want to claim as an expense on their 2022 financial statements (and can), and not have to actually pay that invoice until the following month.
Separately, a businesses ‘cashflow’ is simply its cash inflows compared to its cash outflows for a given period, which can be used to predict or forecast the available cash balance at the end of that period. This is represented on a separate financial statement, called a statement of cash flows. On that report, a business will note down its predicted cash inflows from customers (based on the payment terms of the invoices they have issued to customers), and expected cash outflows (payments to suppliers, interest payments to banks on their loans, rent payments etc.), to determine a predicted movement in their actual bank balance at the end of that period.
A statement of cashflows is more of an operational or management report, increasing a business owners decision making capabilities and financial security, by ensuring they will have sufficient cash available for any potential upcoming expenses.
Combining the two reports and sources of information, a profit & loss statement will allow a business to assess its profitability and overall performance, while a statement of cashflows will allow a business to plan for the future and ensure they can keep their activities running seamlessly, helping to generate further profits going forward.