Why can a profitable business run out of cash and how is the difference reconciled?
Explain and reconcile the difference between profit and cash flow to manage the financial sustainability of a business
Profit is measured on the accrual basis; cash flow records actual movement of money. Non-cash items, credit transactions, asset purchases, loans and drawings cause the two to differ, which is why a profitable business can still be short of cash.
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What this dot point is asking
You need to explain why profit and cash differ, identify the items that cause the gap, and reconcile a profit figure to operating cash flow.
Two different questions
Profit answers "did the business trade well over the period". Cash flow answers "can the business pay its bills as they fall due". They use different bases, so they rarely agree.
Reconciling profit to operating cash
To move from accrual profit to cash from operations, add back non-cash expenses and adjust for changes in working capital. A rise in debtors means less cash than profit; a rise in creditors means more cash than profit.
The decision-making lesson
A business must manage both. Strong profit with weak cash signals that growth is tying money up in working capital, or that the owner is drawing too much. The remedy is faster debtor collection, tighter inventory, or arranging finance for asset purchases, all decisions informed by reading profit and cash together.
The reverse case also matters. A business can report a loss yet still generate positive cash, for example when a heavy depreciation charge drags profit below zero while the underlying trading collects cash steadily. This is why lenders and owners look at operating cash flow alongside profit when judging financial sustainability: profit measures performance under the accrual basis, but it is cash that pays wages, suppliers and loan instalments. A sustainable business is one whose operations generate enough cash over time to fund its own growth and meet its obligations without relying permanently on new borrowing or owner contributions.
Exam-style practice questions
Practice questions written in the style of SACE Board exam questions on this dot point, with worked answer explainers. The year tag is the paper they imitate, not the source.
2022 SACE Stage 22 marksExplain why the change in cash calculated in the statement of cash flows is not the same as the profit figure of $9,960 for Family Likenesses.Show worked answer →
Profit is measured on the accrual basis, while the change in cash records only actual money received and paid, so the two differ for several reasons:
- Non-cash expenses such as depreciation (7,000) and bad debts reduce profit but do not use cash.
- Credit transactions: revenue is recognised when earned and expenses when incurred, but cash is received from debtors and paid to creditors at different times, so changes in debtors, creditors and accruals affect cash but not profit.
- Cash items outside the income statement: buying the van and equipment, additional capital contributions and drawings all move cash but do not appear as profit.
Markers reward at least two distinct reasons, ideally naming a specific non-cash item (depreciation) and a balance sheet movement (debtors, creditors, asset purchase, capital or drawings).
2023 SACE Stage 23 marksThe profit for Lakeland Sports was $5,200 for 2023. Using examples from the statement of cash flows, explain why the change in cash from 2022 to 2023 is a negative value.Show worked answer →
A business can be profitable yet still see cash fall, because profit and cash measure different things.
Point to outflows in the statement of cash flows that are larger than the operating cash generated, for example:
- Investing outflow: 25,000 received from fixtures and fittings (a net investing outflow of $15,000).
- Financing and operating outflows: mortgage interest and loan-related payments, plus payments to creditors and operating expenses, drawing cash out.
Because these cash payments (especially the equipment purchase) exceeded the cash brought in, the net change in cash is negative even though the income statement still reports a $5,200 profit. Profit also includes non-cash items such as depreciation that do not drain cash.
Markers reward linking the negative cash movement to specific outflows (notably the investing outflow) and noting that profit includes non-cash and accrual items.
2024 SACE Stage 22 marksExplain why the budgeted cash balance at the end of June 2025 does not have to be the same as the budgeted profit for the quarter ending June 2025 for Kyandi's Kreations.Show worked answer →
The cash budget and the budgeted income statement measure different things, so their closing figures rarely match.
- Timing of receipts and payments: credit sales are earned now but collected later, so profit includes sales the business has not yet received in cash; likewise some expenses are incurred but not yet paid.
- Non-cash items: depreciation (for example the $350 in general expenses) reduces profit but not cash.
- Cash items not in profit: loan repayments of $1,400 per month and the owner's drawings reduce cash but are not expenses, while the opening bank balance (here negative) carries into the cash figure.
Because of these differences, the closing cash balance reflects only money moved, whereas budgeted profit reflects revenue earned less expenses incurred. Markers reward naming at least two reasons such as timing, non-cash items, and cash flows outside the income statement.