In a given period, any of the following activities will generate cash:

  • Net profit made in the period
  • Increase in share capital during the year
  • Increase in any liability during the year
  • Decrease in any asset during the year

Net Profit as a Source of Cash

Net profit is obviously the most apparent source of cash in any period.

To prepare a cash flow statement for a company, the starting point is net profit as disclosed by the profit and loss account (i.e., the profit before deducting any corporation tax for the year, any dividends for the year, or transfers to any reserves).

The reason for considering profit before tax and dividends is obvious: namely, taxes and dividends are paid after the end of the financial year and, hence, do not form part of the cash outflows for the year.

However, all profit is not earned in the form of cash. Therefore, the net profit figure disclosed by the profit and loss account needs to be adjusted in some respects to arrive at the amount of cash generated through normal trading or operational activities.

These adjustments account for non-cash expenses and non-cash incomes, as well as items that do not fall within the definition of the company’s normal operational activities.

Frequently Asked Questions

How is net profit adjusted to arrive at the amount of cash generated through normal trading activities?

Adjustments are made for non-cash expenses and non-cash incomes, as well as items that do not fall within the definition of the company’s normal operational activities.

What are the most common sources of cash for a business?

The most common sources of cash for a business are accounts receivable, inventory, and investments. Other sources of cash include loans from banks or other lenders, lines of credit, and advances from customers.

How can a business manage its sources of cash?

A business can manage its sources of cash by evaluating its financial situation and identifying the most advantageous sources of cash available to it. A business can also use Cash Flow forecasting to predict its future cash needs and ensure that it has enough cash on hand to meet its obligations.

What are the benefits of managing sources of cash?

The benefits of managing sources of cash include improved financial stability, increased liquidity, and better access to capital. By managing its sources of cash, a business can ensure that it has the resources it needs to meet its financial obligations and grow its business.

What are the risks of not managing sources of cash?

The risks of not managing sources of cash include missed opportunities, lost sales, and decreased profitability. A business that does not manage its sources of cash may find itself in a difficult financial situation where it does not have the resources it needs to operate successfully.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website, view his author profile on Amazon, or check out his speaker profile on the CFA Institute website.