Profit is the result for the year, while capital movement is what happened to the owner’s stake after profit, drawings and any new capital. Neither is the same as cash. You will be asked to explain these differences in words and in short calculations.
This lesson builds on accounting for drawings and belongs to sole-trader statements. The aim is to leave you able to say clearly why three different figures can exist for the same business.
What are the three different questions?
Each figure answers a different question about the year.
- Profit: how much did the business earn after the costs of earning it?
- Capital movement: how much did the owner’s stake change?
- Cash movement: how much did the bank and cash balances change?
Capital movement = profit + capital introduced − drawings. Cash movement depends on the timing of every receipt and payment.
How do you explain the gap step by step?
- Start with profit from the income statement.
- Adjust for items that are not cash: add back depreciation, and subtract sales not yet collected.
- Adjust for cash spent that is not an expense: equipment bought is not a cost in the income statement at purchase.
- Adjust for owner flows: add capital introduced and subtract drawings.
- Compare the final figure with the actual cash movement.
Worked example
Farid’s Print Shop started the year with capital of RM20,000 and cash of RM5,000. During the year Farid put in an extra RM3,000 of his own money. Profit was RM12,000, and drawings were RM7,500.
The profit was after depreciation of RM1,500 and included credit sales of RM2,000 not collected.
He also bought a printer for RM4,000 cash. Assume inventory and payables did not change and every other item was settled in cash.
Step 1, capital movement:
| RM | |
|---|---|
| Opening capital | 20,000 |
| Add: Capital introduced | 3,000 |
| Add: Profit for the year | 12,000 |
| 35,000 | |
| Less: Drawings | (7,500) |
| Closing capital | 27,500 |
Capital rose by 27,500 − 20,000 = RM7,500.
Step 2, cash bridge:
| RM | |
|---|---|
| Profit | 12,000 |
| Less: Increase in receivables | (2,000) |
| Add back: Depreciation | 1,500 |
| Less: Printer bought | (4,000) |
| Add: Capital introduced | 3,000 |
| Less: Drawings | (7,500) |
| Increase in cash | 3,000 |
Check: 12,000 − 2,000 = 10,000; + 1,500 = 11,500; − 4,000 = 7,500; + 3,000 = 10,500; − 7,500 = 3,000. Closing cash is 5,000 + 3,000 = RM8,000.
Step 3, the explanation: profit was RM12,000, capital rose by RM7,500 and cash rose by only RM3,000. The gap between profit and cash is explained by unpaid customers, the printer and the owner’s withdrawals. You can test the same pattern on the cash versus profit bridge.
What mistake catches students here?
A common slip is to assume that profit is the amount of cash the business has gained.
Mistaken working: profit 12,000, so closing cash = 5,000 + 12,000 = 17,000.
Actual closing cash is 8,000.
The error ignores the receivables, the printer, the extra capital and drawings. The correction is to ask: “Did cash actually move?” Profit is an accounting measure for the year.
Cash is a balance in the bank. The difference between 17,000 and 8,000 is 9,000, which equals 2,000 + 4,000 + 7,500 − 3,000 − 1,500 = 9,000.
Check yourself
Try these on paper first, then open each answer.
1. Opening capital RM15,000, profit RM8,000, drawings RM5,000, no new capital. Find closing capital and the change in capital.
Show answer
Closing capital = 15,000 + 8,000 − 5,000 = RM18,000. Capital rose by RM3,000.
2. Profit is RM6,000. It includes credit sales of RM1,500 not yet collected, and depreciation of RM800. All other items were settled in cash. How much cash did the business earn from operating?
Show answer
6,000 − 1,500 + 800 = RM5,300.
Check: 6,000 − 1,500 = 4,500; 4,500 + 800 = 5,300.
3. Opening capital RM12,000, a loss of RM2,500 and drawings of RM1,500. Find closing capital and explain in one sentence.
Show answer
12,000 − 2,500 − 1,500 = RM8,000. A loss reduces capital in the same way drawings do, so capital fell by RM4,000.
Where does this lead next?
The next lesson shows how to check that the statements agree, without forcing a figure: check agreement without forcing a balancing figure. You can also test your reasoning in the mixed practice set.
If you can calculate every figure but cannot find the words to explain it, our teachers can work on that in online one-to-one Accounting tuition.