Profit but no cash: why does this happen?
The report shows a 60 million profit, yet there is almost nothing in the bank. We unpack the gap between profit and cash flow step by step using the indirect method from NAS No. 9.
Profit is calculated when income and expenses are recognised, while money moves when it is paid and received. These two events often do not happen in the same month. That is why a profitable company may have no money in its account.
Key points
- If products are sold on credit, there is income but no money yet: an increase in receivables "eats up" cash
- If more goods are bought for the warehouse, money goes out, but this is not yet an expense: an increase in inventories also reduces cash
- If the supplier is paid later, there is an expense but the money has not gone out yet: an increase in payables temporarily increases cash
- Depreciation (amortisation) is an expense but not a cash outflow: it reduces profit but not cash
- Under NAS No. 9, cash flows are divided into three types: operating, investing and financing activities
- To find net cash flow from operating activities using the indirect method, profit is adjusted for changes in inventories, current receivables and payables, for non-cash items, and for items that give rise to investing or financing cash flows
- If profit grows year after year while operating cash flow stays low, this is a sign of problems in collecting money from customers or managing inventories
Example: Sardor's "Yashil Bog'" plant nursery
At year end, net profit is 60 million soum. Sardor looks at the money in the bank and is puzzled: it has barely changed. Amounts in millions of soum, hypothetical.
| Item | Amount |
|---|---|
| Net profit | 60 |
| + Depreciation (an expense with no cash outflow) | +15 |
| − Increase in receivables (gardening firms bought on credit) | −50 |
| − Increase in inventories (seedlings and fertiliser for next spring) | −30 |
| + Increase in payables (fertiliser to be paid for later) | +10 |
| Net cash flow from operating activities | 5 |
Of the 60 million profit, only 5 million came back as cash. The rest is sitting in customers' debts and in the warehouse. Sardor's first task: draw up a plan to collect the 50 million of receivables.
Test yourself
5 questions on this topic: pick an option or reveal the answer.
The annual net profit of a joint-stock company was 90 mln soum, of which 36 mln soum was allocated to dividends (hypothetical example). What is the dividend payout ratio (dividends / net profit × 100%) and what does it mean?
A joint-stock company's annual net profit is 90 mln soum, of which 10 mln soum is directed to dividends on preferred shares. The weighted average number of ordinary shares outstanding during the year is 40 000. What are the earnings per ordinary share (EPS = (net profit − preferred dividends) / number of ordinary shares)?
Retained earnings of the reporting period were allocated to paying dividends to the founders. What journal entry is made?
The "Shirin non" bakery has annual revenue of 120 mln soums and net profit of 18 mln soums. What is the return on sales (net profit / revenue)?
A workshop's monthly fixed costs are 12 000 000 soums. One unit of product sells for 50 000 soums, and its variable cost is 30 000 soums. How many units is the break-even point (the volume with neither profit nor loss)?
Answered: 0 / 50 of 5 correct
All tests →See also
Sources
- NAS No. 9 "Statement of Cash Flows", paragraphs 6, 15 and 17 · three types of activities; direct and indirect methods; under the indirect method, profit is adjusted for changes in inventories, current receivables and payables, for non-cash items such as depreciation, and for items that give rise to investing or financing cash flows
- Example and amounts · prepared by the author, hypothetical