How to calculate cash profit
/What is Cash Profit?
Cash profit is the profit recorded by a business that uses the cash basis of accounting. Under this method, revenues are based on cash receipts and expenses are based on cash payments. Consequently, cash profit is the net change in cash from these receipts and payments during a reporting period. This is quite a useful measurement, for it reveals whether you are generating or losing cash.
Cash profit does not include other types of cash receipts and payments than those involved with the sale of goods or services. Thus, a cash receipt from the sale of a fixed asset or of company shares or bonds is not considered a cash receipt to be included in the calculation of cash profit.
How to Calculate Cash Profit
If you are using the accrual basis of accounting, it is a bit more difficult to calculate cash profit. In this case, it is called operating cash flow, and iscalculated by stripping all non-cash expenses out of the reported profit figure. The formula is as follows:
EBITDA - Change in working capital = Cash profit
In this formula, EBITDA is earnings before interest, taxes, depreciation, and amortization. The change in working capital refers to the change in the net amount of current assets and current liabilities over the reporting period.
A variation on the concept is to simply subtract all cash outflows from all cash inflows to arrive at the cash profit figure; this approach is used in the following example.
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Example of How to Calculate Cash Profit
As an example of how to calculate cash profit, a company has the following financial data for the year:
Revenue (all cash): $300,000
Cash paid for inventory and supplies: $120,000
Cash paid for wages and salaries: $70,000
Cash paid for rent and utilities: $25,000
Depreciation expense (non-cash): $15,000
Other cash operating expenses: $20,000
The steps needed to arrive at the firm’s cash profit figure are as follows:
Step 1: Add all cash inflows from operations
The cash inflow from sales (revenue) is $300,000.
Step 2: Subtract all cash outflows from operations
The cash outflows experienced by the business are noted below:
Inventory and supplies: $120,000
Wages and salaries: $70,000
Rent and utilities: $25,000
Other operating expenses: $20,000
(Ignore depreciation – it is non-cash)
Therefore, the total cash outflows are as follows:
$120,000 + $70,000 + $25,000 + $20,000 = $235,000
Step 3: Calculate Cash Profit
Cash Inflows − Cash Outflows = $300,000 − $235,000 = $65,000
The cash profit is $65,000, reflecting the actual cash generated from day-to-day operations, excluding non-cash items. This gives a more accurate picture of liquidity than net income, especially for small businesses that are focused on cash flow.
Cash Profit vs. Cash Flows
The cash profit concept closely relates to the net change in cash flows that an organization experiences during a reporting period. The difference between the change in total cash flows and the cash profit is that the cash profit only relates (as just noted) to the sale of goods or services.
Cash Profit vs. Accrual-Basis Profit
A company using the accrual basis of accounting will likely not record the same amount of profit as would be derived from the cash profit calculation. This is because the accrual basis records revenue based on goods or services provided, and records expenses based on consumption, irrespective of any changes in cash flow. Thus, the timing of revenue recognition is accelerated under the accrual basis of accounting if goods or services are sold on credit, while a cash basis organization will wait to recognize the revenue until customers have paid in cash. The timing of expense recognition is accelerated under the accrual basis if suppliers issue goods or services to the buyer on credit, so that cash payments are delayed.
In short, the differences between the accrual basis and cash basis of accounting make it quite likely that the net profit figure will be different from the cash profit figure reported by an entity.