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UNDERSTANDING CASH AND PROFIT

Extending credit to customers is one method often used by businesses to help increase sales

CUSTOMER CREDIT

The profit & loss statement records:

• what a company sells during a period, whether or not it is paid for in cash.

The cash flow statement records:

• only actual cash that moves in and out of the company.

The balance sheet records:

• the amount owed by customers - an asset called accounts receivable

 
ACCOUNTS RECEIVABLE

The money owed by customers will enter the cash flow of the company in the period when the accounts are paid.

RETAINED EARNINGS AND PROFIT

Profit or loss made in previous periods and kept in the company

 = Retained Earnings

Both retained earnings and profit/loss of the current period are recorded under liabilities on the balance sheet.

DAY TWO

Lots of hungry children want to buy a sandwich, but don't have money with them.

JS can sell more, if the children are allowed to buy now and pay tomorrow, after getting the money from their parents.

JS orders two boxes of sandwiches from fast food and keeps track of the credit given.

KEY TIPS

• The Profit & Loss Statement shows what is sold

• The Cash Flow Statement shows what is paid for in cash

Therefore: Profit/Loss does not equal to Cash Flow

• Credit extended to customers appears on the assets side of the balance sheet as accounts receivable

• Extending credit to customers squeezes cash flow

• The balance sheet shows retained earnings on the liabilities side  

>>> Next on Finance Basics: Delaying Cash Payments

Related Articles:

3 Basic Business Statements 
Starting the Business 
The Basic Links 
Understanding Cash and Profit 
Delaying Cash Payments 
Period Costs 
Holding Inventory 
Loan Financing 
Write Offs 
Production Ventures 
Accounting for Inventory 
Business Profitability