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Profit vs. Cash Flow Revisited: “The Matching Principle”

Posted on October 1st, 2017

Jack Kern
Owner, President
Outsourced Accounting Department, Inc.

In two of my previous articles, “Profit vs. Taxable Income,” “Profit and Cash Flow Made Easy,” I explained the difference between Profit and Cash Flow.  However, from time to time I find that some clients still have difficulty in grasping this concept of accrual accounting.

In a nutshell, accrual accounting has to do with the “Matching Principle” of accounting, as further explained in this article from the Accounting Coach: “What is the Matching Principle?.” Simply stated, accrual accounting involves the matching of revenues and their related costs within the same accounting period (i.e., a month), NOT for instance, when materials are purchased in one month and customer payments are received in another. The first scenario tells you your profit, the second tells you your cash flow.

An awareness of the above differences is critical to understanding your business’ operating performance.  For instance, assume your cash flow seems very tight.  What is the most appropriate corrective action?  Is the solution to cut expenses, or, is it to improve turnover of accounts receivable or inventory?  Understanding these differences also affects your ability to accurately plan your company’s future profitability, and the funding required to support future growth.  In other words, understanding these differences is critical to your company’s very survival.

Related Articles:

The Effect of Sales Growth on Cash Flow

The Relationship Between Turnover Ratios and Cash Flow

What is My Breakeven Point of Sales?

Financial Planning, or Business Turnaround – Your Choice

 


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