Cash flow: the bridge from profit
Introduit| English | Sens |
|---|---|
| cash flow statement | Cash movements classified as operating, investing and financing. |
| operating activities | Cash from running the business itself. |
| investing activities | Cash from buying and selling long-lived assets. |
| financing activities | Cash from raising and repaying shares and loans. |
| indirect method | indirect method |
£28,370 of profit, £51,400 more cash
- In year 1 Nimbus made £28,370 of profit, but its bank balance rose by £51,400. Neither number explains the other.
- The cash flow statement builds the bridge between them, line by line. This lesson shows how, and why a profitable firm can still run short of cash.
Three kinds of cash movement
- The cash flow statement 现金流量表 sorts every movement into three groups. Operating activities 经营活动: the bread business itself. Investing activities 投资活动: buying or selling long-lived assets such as the oven.
- Financing activities 筹资活动: money from or back to the funders, such as shares, loans and loan repayments. Year 1: investing −6,000 (the oven), financing +35,000 (shares and loan).
Operating, investing or financing?
Sort each of Nimbus's cash movements. Operating cash comes from the bread business, investing cash buys or sells long-lived assets, and financing cash comes from or goes back to the funders.
In year 2 Nimbus repays £5,000 of its bank loan. Where does this appear?
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Repaying the amount borrowed is money back to a funder, so it is financing. Interest on the loan is usually shown under operating.
Why profit is not cash
- Profit is measured on the accrual basis, so it counts expenses that moved no cash and ignores cash that bought nothing used up yet.
- Depreciation of £1,080 lowered profit but no money left the bank that year. The £9,000 of prepaid rent left the bank but is not yet an expense.
Depreciation of £1,080 reduced Nimbus's bank balance by £1,080 during the year.
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The cash left when the oven was bought. Depreciation spreads that cost over the years, which lowers profit but moves no cash.
Bridge rules: undo the accruals
- Start from profit. Add back expenses that moved no cash: depreciation and accrued expenses.
- Subtract growth in inventory and prepayments: cash spent on things not yet used. Add growth in payables: goods used but not yet paid for. This is the indirect method 间接法.
Payables grew by £4,000 during the year. How does this enter the bridge from profit to operating cash?
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Payables growing means cash stayed in the bank. Inventory and prepayments growing do the opposite and absorb cash.
Match each change to its step on the bridge.
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Each step undoes a difference between the accrual basis and the bank account.
Nimbus's bridge, year 1
| Profit to operating cash | £ |
|---|---|
| Profit | 28,370 |
| + Depreciation | 1,080 |
| + Accrued wages, electricity, interest | 1,550 |
| − Growth in inventory | (3,600) |
| − Growth in prepaid rent | (9,000) |
| + Growth in payables | 4,000 |
| Operating cash | 22,400 |
| Investing (oven) | (6,000) |
| Financing (shares and loan) | 35,000 |
| Change in cash | 51,400 |
- £51,400 is exactly the cash line in the balance sheet, so the statements agree.
Year 2: profit £30,000, depreciation £1,080, inventory grows by £1,000, money owed by cafés grows by £6,000 and payables grow by £500. What is operating cash, in £?
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$30\,000 + 1\,080 - 1\,000 - 6\,000 + 500 = 24\,580$. Selling to cafés on credit holds back £6,000 of cash.
Three reasons profit and cash part ways
- Timing: cash moves before or after the expense or sale, as with the prepaid rent. Growth: more stock and more customers on credit trap cash while profit looks fine.
- Funding: shares and loans bring cash with no profit at all. Profit £28,370 against operating cash £22,400 is a £5,970 gap: $(9\,000 + 3\,600) - (1\,080 + 1\,550 + 4\,000) = 5\,970$.
Profit is £28,370 and operating cash is £22,400. What explains the £5,970 gap?
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$12\,600$ of cash went into prepaid rent and stock, against $1\,080 + 1\,550 + 4\,000 = 6\,630$ added back: $12\,600 - 6\,630 = 5\,970$. The oven and the financing are outside operating cash.
Three common slips
- Adding back the whole rent payment. Only depreciation and accruals are added back; the prepayment belongs in the working-capital lines.
- Putting a loan repayment under operating. Repaying the loan is financing. Interest is usually shown under operating.
- Reading strong operating cash as proof of health. Check financing too: a firm can hold plenty of cash while its bank is asking for the loan back.
Which could leave a profitable business short of cash? Select all that apply.
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Late payment and stock build-up trap cash; a loan repayment sends it back to the lender. Depreciation lowers profit but moves no cash.
Recap
- Cash flows are operating, investing or financing.
- Operating cash = profit + non-cash expenses and accruals − growth in inventory and prepayments + growth in payables.
- Timing, growth and funding explain why profit and cash differ.