Cashflow and profit are two of the most important financial metrics for any business. You need both to be positive in order to survive.
The difference between cashflow and profit
Cashflow is simply your starting cash balance plus cash received less cash paid out. If all transactions were cash, there would be very little need for accountants.
In the real world there are timing differences between, for example, when you raise invoices and when your customers pay you, or when your suppliers bill you and when you pay. There are timing differences between when you buy trading stock and when you sell it. There are timing differences between when you buy plant and equipment and when you have used it for the last time. There are many other timing differences. Accrual accounting is the system that takes all the timing (non-cash) differences into account.
Cash accounting deals only with cash movements. Accrual accounting deals with all cash movements plus all non-cash transactions.
Incidentally, the non-cash transactions explain why you have to pay tax when you have no money in the bank (a question frequently asked of accountants)..
Why is accrual accounting important?
Your bank balance tells you how much cash you have on a given date but it does not tell you how much you still owe or how much you still have to receive. If your business is very small you can keep these figures in your head but as you grow the need for accrual accounting grows too.
Accrual accounting estimates your profit (or loss) taking all known factors into account.
Why is cashflow important?
You might have $100,000 owing to you but you might also owe your suppliers $60,000.Accrual accounting lets you know that when these transactions are completed you will be $40,000 better off. However, suppose that you do not receive the $100,000 owing to you for six months but your suppliers demand that you pay them within 30 days. This might leave you with not enough cash to operate for five months or, even worse, you might be forced into bankruptcy. Accrual accounting does not necessarily warn you about this (although it can at a higher level), but your cash flow forecasts should do so. This is why banks will often request monthly or quarterly cash flow forecasts to make sure that you are not going to go broke before making a profit.
Take control of your cashflow
Profit is an excellent measure of your financial success. A cashflow forecast helps to ensure that you do not run out of cash before you realise the profit. They are both valuable.
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