Accounting Information

By Easwar Koovappadi

Cash flow statements alone do not tell you the whole story. Just knowing that cash has increased or decreased by X dollars does not tell us the whole story. Inflows and outflows are the results of various changes in the business, inflows from sales, capital invested, borrowings etc. Cash outflows result from payments being made for purchase of raw materials for manufacture, payroll and other expenses, interest on loan payments, investment in machinery, repayment of loans, payment of taxes etc. While understanding movement of cash is very important, we do not get the full story just by looking at the flows. There are two more reports that we need to look at, to understand the financial health of the business. One deals with the profitability and the other with the financial condition at any period in time.

Profitability is not equal to the increase in cash for any given period. Profit is an accounting determined number that primarily arises after matching costs with revenue. Stated simply, the cost of manufacturing Widget A is $3. Cost to sell Widget A is $1. The Widget A sells for $5. Profit is the sale value less cost of making and selling it. In this case, the profit is $1.

Let us assume that the company sells on credit to its customers. At any time, the company may have "receivables" from its sales. Receivables may also include cash that is yet to be collected for sales made in the earlier year. The company also purchases raw materials, supplies etc on credit. The company may yet need to pay for the materials that it has already converted. These products may be sitting in its inventory. Profit is considered as earned only when an item is sold. The company also may have unpaid expenses at the end of the year.

In short, cash flows from sales and expenses are not the correct amount to measure profitability. Profitability is always measured by sales revenue less the cost of making and selling the product. It is the obligation of the business owner/manager to manage cash in such a manner that obligations are met on time.

Easwar has an extensive knowledge of issues related to currency exchange, taxes, cost savings ideas and loves to write about it. For additional resources please visit http://www.improveprofitsnow.blogspot.com

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