Appendix B The difference between cash and profit

1. The Question

In appendix A you find an exercise, where you make a profit and loss statement from a stock record, the depreciation summary and the cash book. There you find the following figures:

· The Retained Profit from the 1st January to 31st March is LU 63’000
· The Cash on Hand in the Cash Box on 31st March is LU 85’000

Question: Where does this difference come from?

2. Where the Difference Comes From

The difference between cash and profit can be explained by the following:

· Investments (“new moulds”) reduce the cash, but they are not expenses. Investments are irregular and large cash transactions. If they were included in the expenses, the result of the profit and loss statement would be distorted.

· Depreciation is an expense but it does not reduce cash.

· Loan Repayments reduce cash, but they are not expenses. Loan repayments are irregular and large cash transactions. If they were included in the expenses, the result of the profit and loss statement would be distorted. However, the costs of loans are taken into consideration. The loan interest is an expense (and also reduces cash).

· Changes in the value of stock change the profit but do not change cash.

3. Example

In the case of Garcia’s tile factory, the difference between cash and profit can be explained by the following calculations:

Final Cash = +85’000
Less: Initial cash (On the 1st of January) = -60’000
= Cash difference between 1.1. and 31.3. = +25’000
Plus: Investments (reduced cash, but not profit) = + 70’000
Less: Depreciation (reduced profit, but not cash) = - 15’000
Less: Stock changes (reduced profit, but not cash) = -17’000
= Retained Profit = 63’000