Accounting Mistake in Understanding of “Profit”
We should love mistakes. Each mistake has an opportunity to make you wiser. Let’s understand the mistake of misunderstanding profits. The most of students think that more the profit is, more the richer organization. But it is not correct. Cash is blood of a organization and organization cannot run when cash is dried out. The reason behind this is :
“Accounting is based on double entry system and concept of accrual, meaning there by the profit are earned as a result of financial transactions.
Accrual concept tells to recognize the revenue on received and receivables. Thus profit earned is not equivalent to cash balance.”
We need to understand the difference between
Cash is your cash in hand and it includes Bank balances, Short term Investments.
Revenue is inflow of money in to business and it includes Sales, and also moneys received otherwise in mode of Loans or by sale of assets.
Profit is Sales Revenue minus All expenses related to Sales.
Thus, we need cash to meet out expense and sales realization to regenerate cash.
And profit is not cash. A business can not survive in case cash flows are negative.
Profitable business can run out of money due to a lack of cash flow, and there’s no way around it. To run a business, you have to mind cash flow, not just profits.
This may also cause to cash insolvency which is term used to explain a situation when you don’t have enough cash to repay your financial creditors. This may be the case your profits are positive, but your cash inflows are negative and your organization can be sued under insolvency and bankruptcy code for non payment of your creditors above a certain limit.
Conclusion: Good financial position is outcome of good profits and sound cash flow positions
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