Guest post by Peter Baskerville. Read the original post on Quora: How is it possible that cash flow generated by operations could be greater than net profit?
This is a common dilemma that small business owners often mismanage … the fact that excessive cash at bank does not necessarily mean profit that the owners can use.
It’s all about the timing. See cash from sales for most businesses happens daily and builds up in the bank account over time. But the expenses incurred in making those sales is rarely paid out on a daily basis from the bank account and is more likely paid at the end of the week for expenses like staff and supplies, at the end of the month for expenses like rent and electricity, and at the end of the year for expenses like taxes and accounting fees.
So cash flow from operations is always greater than net profit simply because there is a timing delay between an expense being incurred and an expense actually being paid from the bank account. This delay causes the cash at bank to always be much higher than the actual profit earned.
Also, not all expenses that reduce profit, impact on cash. For example, depreciation on equipment and amortization on intellectual property rights. While these expenses reduce profit they don’t impact in any way on the cash flow causing the cash flow to be greater than the net profit.
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