Cash flow and profit 6 / 7

The distinction between cash flow and profit and the relevance of cash flow to capital investment appraisal

For example

Let’s say you buy some goods for $100 and sell them for $200. 

However, $80 of the receipt is on credit and you have not received it yet.

Profit looks solely at the income and costs. It matches these together, regardless of timing of the actual cash payment or receipt.

Sales $200
Costs ($100)
Profit $100

Cash flow, on the other hand, does not attempt to match the sale with the cost but rather the actual cash paid and received.

Cash received  $120 
Cash paid  ($100)
Increase in Cash flow $20

Therefore, cash flows look at when the amounts actually come in and out: - the money actually spent, saved and received. 

This is vital to capital investment decision making - as the timing of inflows and outflows have a value too - the time value of money.  

Not only should the timing of the cash flows be taken into account when planning on investments but also the type of cash flows to include. 

We call these relevant costs.