Page 98 - Finance for Non-Financial Managers

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Profit vs. Cash Flow
profits as a result of the loan—aside from the good things you
might do with the money later that will improve profits. But you
don’t get to keep the money forever; sooner or later you have to
repay it. That comes up in the next section.
Closely related, particularly for new companies, is the effect
of having outsiders invest in their company. The investors write
a check and the company banks the check and issues stock to
its new investors. The company can use that money, but it will
never appear in the income statement. Wonder Widget started
operations with money like that, and it was recorded directly on
the balance sheet as capital stock, not in the income statement
as sales of stock.

Type 4. Transactions That Take Cash but May or May Not
Affect Profits Later

Do you remember the loan that puts cash in the bank without
recording a profit increase? Well, the repayment of that loan is
the flip side—money is paid out but there’s no reduction in prof-
its. Of course, while you have the loan outstanding, you’ll have
to record and pay interest on it, which is recorded as interest
expense on your income statement. But the principal reduction
portion of your payment is simply returning the money to the
bank, a transaction that affects both sides of your balance sheet
but not your income statement.
Another example of a cash payment with a delayed impact
on profit is the purchase of assets for a business—machinery,
automobiles, etc.—that will typically benefit the company for a
number of years. A manufacturing company might buy the pro-
duction equipment by paying cash for equipment that might
last five or 10 years or more. Because the assets are purchased
to benefit the business for years to come, accounting standards
require that the cost of those assets be charged to income over
the periods that received the benefit, not the month in which the
assets were purchased and paid for.
Of course, a manufacturer might choose to finance its pur-
chases through installment contracts or leases and thus bring its