Profit and Loss or Cash Flow, which one is more important? A classic problem in one of the modern business accounting fields is often disputed, some assume that profit is the most important thing in the company but the rest argue that cash flow is the most crucial part. Before we get stuck into 2 partial paradigms let’s first find out what Profit and Cash flow are and their functions in the business application. Ideally a business is run under the “Cash” system, meaning that all transactions are made in cash, from purchases, sales, and other various payments. In these circumstances, cash flow will be equal to the profit value. However it is hard to apply this system, thus payable and receivable could not be avoided. This is what eventually led to differences and debates about the importance of profit and loss or cash flow.
First, as in the process of making financial statements or profit /loss is one of the important elements often considered. It is calculated from the left or exceed sales and purchase transactions. In other words that the company’s earnings obtained from the sales of goods or service revenue is subtracted from cost of goods sold or production costs and operational costs and other costs. Profit is obtained from the sales, both in cash and credit. Often we are confused on a report which record high profit, but in fact, on the other hand the value of our cash balance is minus and no benefits at all.It shows that high profit but low cash flow.
The second is the cash flow. Cash flow is the incoming and outgoing cash flows. If the incoming cash is bigger than cash out, then it will make cash flow positive or surplus. Conversely, if the incoming cash is smaller than the outgoing cash, this is called negative cash flow or deficit. To understand it easily, cash consists of cash, banks and cash equivalents. The cash flow component consists of Cash In and Out Cash. Generally, the elements of cash in consists of receipts, such as, cash sales, receipt of accounts receivable payment and other receivables and other loan receipts. While the cash out elements consist of expenses or payments, including supplier payments, tax payments, installment payments and loan repayments, operating expenses and other expenses.
So which of these two things is more important? Maybe now we begin to hesitate to determine which one is more important, profit or cash flow? Those two points are indeed very important in assessing our business. None is considered better than others. Basically these two reports are required to review the business financial stability. A business may have high profit, but if most of the profits are receivables, moreover bad debts, it may cause problems. The business still needs cash to run its activities, this would be a serious probably for the business. However the owner may gave a very good cash flow value (surplus / positive) regardless of which element value of cash entry. But the question is how if most of the cash comes not from the element of income but rather from other things such as customer receivables payment, employees loan payment or additional capital participation. In this case, our cash flow value is positive but basically we suffered losses because income from earning element is very small while the operational and non operational costs remain. This condition can be dangerous for the business development and sustainability.
However, we still put on the options: Profit or Cash Flow, which is more important? So the answer is cash flow. If we have cash, even though our profit is low or even minus, our business can still run and the management shall plan a strategy to increase profit for the next period. If profit is gained but there is cash availability, then it will lead to business collapse. Using both financial statements (profit and cash flow) are very recommended to apply, since they are the guide to analyze the business. Basically both reports are a unified system in determining the strength and development of a business.
