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What is the difference between cash, cashflow and profit?

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21 May 2012

Many businesses find it difficult to differentiate between cash, cashflow and profit. In this article we examine some of the key distinctions.

Cash is the liquid assets of the business, i.e. funds immediately available such as coins and notes, bank balances and overdraft facilities and therefore does not include money held on long term deposit or money owed by patients.

Cashflow is the cash movements into and out of the practice.

From an accounts perspective, profit is income less expenses. Whilst this may sound similar to cashflow, there are normally several non-cash accounting adjustments in the profit and loss account. These include:
 
  • Depreciation. When an asset is purchased it is capitalised for accounting purposes. The cost is then written off to the profit and loss account over its useful economic life.

    For example, a new computer may cost £1,000 and be expected to last four years. The cash outflow occurs when the computer is actually purchased. For accounting purposes 25% of the cost, £250, is included as the depreciation charge when calculating profit each year.
  • Amortisation. This is similar to depreciation, only for intangible fixed assets. The most common example is the write off of goodwill.
  • Profit or loss on disposal of assets. For accounting purposes, the profit or loss is the difference between the net book (depreciated) value and the proceeds actually received.
  • Debtors. Where patients receive treatment this is recognised when calculating profit. However, they may not pay immediately so there is no cash inflow until payment is actually received.

    Another example is NHS contract income which is normally received at the beginning of the following month (in arrears). This should be recognised for accounting purposes however the cash inflow would occur in the following month.

  • Creditors. This is similar to debtors, whereby invoices for goods or services received from suppliers are recognised when calculating profit, however there is no cash outflow until the supplier is actually paid.
  • Prepayments. Where goods or services are paid for in advance the cost is deferred to match against the corresponding accounting period. A typical example is rent paid in advance.
  • Accruals. Similar to prepayments, an accrual for costs relating to the accounting year can be made without an invoice actually being raised in the year. An example of this is accountancy fees.
  • Stock movement. If the level of stock of materials and goods for resale increases this is a cash outflow (and vice versa). For accounting profit purposes stock in hand is matched against the corresponding fee income (materials) or sale (goods).

In addition to the above, there are some cash movements which are not reflected in the profit and loss account. Examples include:

  • Purchase of fixed assets such as computers, dental equipment, office furniture or a car (see example above).
  • The proceeds from the sale of an asset such as a car.
  • The receipt of a bank loan or an increased bank overdraft.
  • The repayment of the capital element of a loan or hire purchase agreement. Remember it is only the interest element which is deducted against accounting profit.
  • For sole traders and partnerships, drawings to pay personal living costs, tax and National Insurance liabilities or pension contributions.

Given all of the above differences, it is possible to make a profit and still have a negative cashflow. Managing the practice’s cashflow is therefore very important and this will be the subject of next quarter’s article.