Profit and cash answer different questions. Profit asks whether the business earned more than it cost in a period. Cash asks how much money moved. This page builds a one-month example, reconciles the two and shows the mistake students make.
Why do they differ?
Three kinds of difference explain almost every gap.
- Timing of sales and costs: a credit sale is revenue now and cash later; insurance paid for a year is cash now and expense spread over the year.
- Items that are not profit: buying equipment is an asset, and owner’s capital or drawings change cash but not profit.
- Non-cash charges: depreciation reduces profit but does not move cash.
The cash versus profit bridge shows the same example with assumptions stated, and the percentage-base explorer helps if a question asks for profit as a percentage of sales.
A worked example: one month
Sari starts a small trading business on 1 March. These things happen in March.
- The owner puts RM4,000 into the business bank account.
- Goods bought for RM1,500 in cash, all sold in March.
- The goods are sold for RM2,400: RM1,000 in cash and RM1,400 on credit. The customer will pay in April.
- Wages of RM600 paid in cash.
- Equipment bought for RM900 in cash. Assume depreciation is ignored this month to keep the focus on cash.
- Insurance of RM360 paid in cash for 12 months starting in March.
The profit
| Item | RM |
|---|---|
| Sales | 2,400 |
| Less cost of goods sold | (1,500) |
| Gross profit | 900 |
| Wages | (600) |
| Insurance (360 ÷ 12 × 1 month) | (30) |
| Profit for March | 270 |
The cash
| Item | RM |
|---|---|
| Capital introduced | +4,000 |
| Goods bought | (1,500) |
| Cash from sales | +1,000 |
| Wages | (600) |
| Equipment | (900) |
| Insurance | (360) |
| Cash at end of March | 1,640 |
Check: 4,000 − 1,500 + 1,000 − 600 − 900 − 360 = 1,640.
The bridge
| Step | RM |
|---|---|
| Profit | 270 |
| Less increase in receivables (credit sales not yet collected) | (1,400) |
| Less increase in prepayments (360 paid, 30 used, so 330 is for later) | (330) |
| Cash from trading | (1,460) |
| Less equipment bought | (900) |
| Add capital introduced | 4,000 |
| Change in cash | 1,640 |
Check: 270 − 1,400 − 330 = −1,460. Then −1,460 − 900 = −2,360, and −2,360 + 4,000 = 1,640. The bridge ties exactly to the cash table.
So the business made a profit of RM270 and ended with RM1,640 in cash. Neither figure predicts the other, and the reason is timing and non-profit items.
The mistake to avoid
A common slip is to treat cash as profit, or to calculate “profit” from cash in minus cash out.
Mistaken answer: cash received 1,000 − cash paid (1,500 + 600 + 900 + 360) = −2,360
This counts the equipment and a full year of insurance as March costs, and leaves out the RM1,400 of sales because no cash arrived yet.
The correction: ask of each item, “does it belong to this month’s income or cost?” Sales are recognised when earned, insurance is spread, and equipment is an asset. Only then compare with cash.
Self-check
1. A sale on credit for RM700 with goods costing RM450. What is the profit on the sale and the cash received today?
Show answer
Profit is 700 − 450 = RM250. Cash received today is RM0, because the customer has not paid yet.
2. A customer pays RM900 owed from last month. What happens to profit and cash this month?
Show answer
Profit is unchanged, because the sale was recognised last month. Cash increases by RM900 and receivables decrease by RM900.
3. A machine costs RM2,000 in cash and is depreciated by RM400 a year. What are the effects in the year of purchase?
Show answer
Cash falls by RM2,000 at once. Profit falls by only RM400, the depreciation charge. The machine stays in the statement of financial position at 2,000 − 400 = RM1,600.
Where to go next
Study separating cash paid from expense recognised, then explaining depreciation rather than expensing the whole asset and profit versus capital movement. Try the accruals and prepayments practice set afterwards.
If credit sales, prepayments and equipment still tangle in longer questions, online one-to-one Accounting tuition gives you a teacher to rebuild the bridge with you.