Cash Flow and why profit is not cash
The three activity sections, how to trace the gap between net income and the change in cash, and what to do about it.
ConceptFor Business owners, Portal clients, Bookkeepers
Three kinds of cash movement
| Section | What it captures | Healthy pattern |
|---|---|---|
| Operating | Cash generated by running the business, after working capital movements. | Positive, and roughly tracking net income over time. |
| Investing | Buying and selling long-term assets. | Negative while growing — you are buying capacity. |
| Financing | Borrowing, repaying, owner contributions and distributions. | Varies. Persistent borrowing to fund operating losses is the pattern to worry about. |
Tracing the gap
The statement starts at net income and adjusts to arrive at the change in cash. Each adjustment is a specific, findable reason profit and cash differed.
- Depreciation is added back — a real expense that consumed no cash this period.
- An increase in receivables is subtracted — you earned it but have not collected it.
- An increase in payables is added — you incurred it but have not paid it.
- An increase in inventory is subtracted — cash converted into goods on the shelf.
- Asset purchases appear in investing, not as an expense.
- Loan principal repayments appear in financing; only the interest is an expense.
- Owner distributions appear in financing, not on the P&L.
Common questions
Working capital has absorbed the profit — usually receivables growing faster than payables, or inventory building. Check A/R aging first: if the receivable growth is in overdue balances rather than current ones, the problem is collections, not growth.
See alsoA/R and A/P aging
Start from open receivables by expected collection date, subtract open payables by due date, add payroll and recurring commitments. The A/R and A/P aging reports plus your payroll calendar cover most of it.
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