A business can make a profit and still run short of cash, because profit is recorded when a sale happens while cash moves when money changes hands. The gap appears when sales are on credit, or when cash leaves for things that are not expenses.
This lesson is part of profit, cost and cash are different questions. The budget side is in preparing a simple cash budget.
Worked example: Kedai Jahit Hana in March
Kedai Jahit Hana is an invented curtain shop. In March it sold curtains worth RM18 000 on credit, and customers will pay in May. The shop paid RM10 000 cash for the goods and RM4 000 cash for wages and rent. It began March with cash of RM6 000.
| RM | Profit view | Cash view |
|---|---|---|
| Sales | +18 000 | 0 (not yet collected) |
| Cost of goods | −10 000 | −10 000 |
| Wages and rent | −4 000 | −4 000 |
| Result | +4 000 profit | −14 000 cash |
The shop made a RM4 000 profit, but cash fell by RM14 000. Opening cash of RM6 000 less RM14 000 leaves a shortfall of RM8 000, so the shop must borrow, or delay its own payments, until customers pay in May.
What are the usual causes?
Use this checklist in written answers.
- Credit sales: profit is recorded now, cash comes later.
- Stock bought: cash leaves now, but the cost only enters profit when the stock is sold.
- Assets bought: cash leaves now, but the cost is spread through depreciation.
- Loan repayments and drawings: cash leaves, but neither is an expense.
The mistake that equates profit with cash
A wrong answer says “the business made a profit of RM4 000, so it has RM4 000 more cash”. That answer ignores the timing of the RM18 000.
A stronger answer names the cause, gives the figure, and states the effect: “RM18 000 of sales were on credit and unpaid in March, so cash fell by RM14 000 despite a RM4 000 profit.”
Check yourself
A business earned a net profit of RM5 000, which included depreciation of RM1 200. Debtors rose by RM3 000. It bought equipment for RM2 500 cash, and the owner withdrew RM1 000. Find the change in cash.
Answer
Start with profit: +5 000.
Depreciation is non-cash, so add back: +1 200.
Higher debtors mean cash not yet collected: −3 000. Equipment bought: −2 500. Drawings: −1 000.
Change in cash = 5 000 + 1 200 − 3 000 − 2 500 − 1 000 = −RM300.
What to study next
Next, separate the cost concepts in separating contribution from profit. You can also watch timing effects in the cash profit and transaction timing explorer.
If you want a teacher to shape your written explanations, see online one-to-one Accounting tuition.