Profit vs Available Cash
Profit is often reported under accrual accounting, where revenues are recognized when earned and expenses when incurred, regardless of cash movement. As a result, sales made on credit may be included in profit, though no cash has been collected. Similarly, expenses such as depreciation or amortization are recorded even though no cash is spent. Prepaid items may be excluded from current expenses despite cash already being paid. Conversely, cash may be received in advance for services not yet delivered, leaving profit unaffected. Loan proceeds can increase cash without affecting profit, while debt repayments reduce cash without reducing profit. Thus, profit reflects economic activity, whereas available cash reflects liquidity, and the two measures are not always aligned.
Economic activity is reflected through the production, exchange, and consumption of goods and services, and it is measured differently under profit and cash perspectives. For example, depreciation, a non-cash expense, is recognized as the systematic consumption of an asset’s value over its useful life. The gradual wearing out of machinery, vehicles, or buildings is reflected in expense allocation. By recording depreciation, the cost of resources is matched with the revenues they help generate, ensuring that profit is not overstated. Without recognition, assets would appear to provide unlimited service, and financial results would be distorted. Through depreciation, economic reality is acknowledged, and capital replacement needs are anticipated, allowing plans for sustainability and the maintenance of accurate financial reporting.
Now, recall that accruals are accounting adjustments that recognize revenues and expenses when they are earned or incurred, rather than when cash is received or paid. This principle ensures that financial statements reflect economic activity in the correct period, aligning income with related costs. Common accruals include unpaid expenses like wages or utilities, and earned revenues not yet collected, such as accounts receivable. Accruals are central to the accrual basis of accounting, which contrasts with cash accounting. They provide a more accurate picture of financial performance but can obscure actual liquidity, making cash flow analysis essential for understanding a company’s real-time financial health.
In accordance, the Generally Accepted Accounting Principles (GAAP) defines profit as net income for U.S. companies, calculated by subtracting all expenses from total revenues. Using accrual accounting, GAAP records revenue and costs when earned or incurred—not when cash moves—so profit reflects matched income and costs but may mask actual cash flow. GAAP distinguishes among gross, operating, and net profit, each showing different aspects of financial health, though results can vary due to accounting practices and estimates.
Contrarily, cash accounting is applied by recording revenues when cash is received and expenses when cash is paid. Transactions are recognized only when money physically enters or leaves the business, which makes the method simple and transparent. Sales made on credit are excluded until payment, and obligations such as wages or bills are ignored until settlement. Because timing differences are not adjusted, financial results are directly tied to liquidity rather than economic activity. This approach is often used by small businesses or individuals, since it provides a clear view of available funds. However, long-term performance may be distorted, as profitability is not measured accurately when revenues and expenses are delayed or prepaid. See the discussion on cash flow vs profit.
Revenues Under Accrual Accounting
To elaborate, revenues under accrual accounting are recognized when they are earned, even if no cash has been received. Sales made on credit are recorded as revenue once goods or services have been delivered, though payment may be collected later. Accrued revenues are also recognized when services have been performed but invoices have not yet been issued. Interest income and dividends declared are included in profit once they are earned, despite cash not yet being received. Deferred revenues, such as customer deposits, are excluded until obligations are fulfilled, even though cash has already been collected. Through these practices, accrual accounting reflects economic activity more accurately, while cash accounting records only actual inflows, creating divergence between reported profit and available liquidity.
Expenses Under Accrual Accounting
Expenses under accrual accounting are recognized when obligations are incurred, even if no cash has been paid. Wages earned by employees are recorded as expenses once the work is performed, though payment may occur later. Utility bills and interest charges are accrued when services are used, regardless of settlement timing. Depreciation and amortization are included as non‑cash expenses, reflecting asset usage rather than cash outflows. Bad debt provisions are recognized when receivables are deemed uncollectible, though no immediate cash is spent. Prepaid expenses are allocated across periods, even though cash was already disbursed upfront. Inventory costs are expensed as goods are sold, not when purchased. Through these practices, accrual accounting captures economic activity beyond actual cash transactions.
So, The Difference Matters
So, profit under accrual accounting captures the economic reality of business activity, and its recognition of revenues and expenses beyond cash transactions allows economic activity to be measured more accurately. Revenues are recorded when they are earned, even if payment has not yet been received, and expenses are recognized when obligations are incurred, even if cash has not yet been paid. By including items such as accounts receivable, accrued revenues, depreciation, and accrued expenses, a clearer picture of profitability is provided. Without these adjustments, financial results would be distorted by timing differences in cash flows, and long‑term viability could not be assessed reliably. Stakeholders are therefore given a more faithful representation of how resources are being utilized and generated.
Therefore, the divergence between accrual accounting and cash accounting matters because liquidity and profitability are not always aligned. A company may appear profitable under accrual accounting while facing cash shortages due to delayed collections, or it may show limited profit while holding strong cash reserves from loans or prepayments. Decisions regarding investment, financing, and regulatory compliance are influenced by these differences, since cash availability determines immediate solvency while accrual measures indicate sustainable performance. By recognizing revenues and expenses that cash accounting ignores, accrual accounting ensures that obligations and entitlements are not overlooked, enabling risks to be identified and managed before they affect liquidity.
By Richard Thomas
