Module 1 of 2 · 75 minutes
Profit, position and cash, and how they differ
By the end of this module you will be able to
- Explain every major line of a profit and loss account
- Interpret a balance sheet, including what it omits
- Explain the difference between profit and cash
- Identify the accruals that move profit between periods
Amara A business reports its best ever profit and cannot pay wages. How?
Nadia Because profit and cash answer different questions, and the accounts are honest about both. A sale is recorded when it is made, not when it is paid for.
Amara Put numbers on that.
Nadia Sell in March on ninety day terms and March carries the profit. The money lands in June. Between those dates the supplier, the staff and the rent have all been paid out of a bank account that has not received anything.
Amara And growth increases the gap.
Nadia Sharply, which is the part people find counterintuitive. Selling more means holding more stock and carrying more unpaid invoices, both funded before a single new customer pays. The fastest growing business in a sector is often the closest to failure.
Amara On the profit and loss account, which line is read first?
Nadia Gross margin, not the bottom line. It tells you whether the thing you sell makes money before the cost of existing. A falling gross margin is a pricing or a supplier problem, and no amount of overhead cutting will touch it.
Amara And a healthy gross margin with poor operating profit?
Nadia A different problem entirely. That is overheads, and it has a different solution and a different owner. The single bottom line hides which of the two you have, which is why the structure matters.
Amara The balance sheet always balances. What does that prove?
Nadia Nothing. It is the accounting equation presented as a statement, so it balances by construction. Accuracy and solvency are separate questions.
Amara What does it leave out?
Nadia The workforce entirely. A brand built over thirty years, unless it was purchased from somebody else. Property may sit at 1994 cost. It is a record of transactions, not a valuation of a business, and it is read as a valuation constantly.
Amara Then what is it genuinely useful for?
Nadia Structure. What is owed against what is owned, how much falls due within twelve months, and how much of the business is funded by borrowing rather than by owners. That is what a lender reads first.
The written material
The profit and loss account
Revenue at the top, then the cost of the things you sold, giving gross profit. Then the costs of being in business at all, giving operating profit. Then interest and tax, giving the profit that belongs to the owners.
The structure matters because each level answers a different question. A falling gross margin is a pricing or a supplier problem. A healthy gross margin with a poor operating profit is an overhead problem. The two have entirely different solutions and the single bottom line hides which one you have.
The balance sheet, and what it leaves out
A balance sheet is a photograph taken at one instant: assets on one side, liabilities and capital on the other, balancing by construction because it is the accounting equation in a suit.
What it leaves out is often what matters most. The workforce is not an asset. A brand built over thirty years usually appears at nothing unless it was bought from somebody. Property may sit at what it cost in 1994. A balance sheet is a record of transactions, not a valuation of a business.
Why profit is not cash
Accounting matches income and costs to the period they relate to, not the period the money moved. A sale made in March is March's revenue even if the customer pays in June. Rent paid annually in advance is spread across the months it covers.
That matching is what makes the profit figure meaningful, and it is exactly what makes it useless as a measure of survival. Growth consumes cash: more sales means more stock bought and more invoices outstanding, both funded before any customer pays.
Knowledge check
The knowledge check and your certificate need a free account, so that your progress and results can be saved as evidence.
The learning itself stays free and open. You are reading all of it right now without an account.