Profit is an opinion, cash is a fact

Why a profitable company can still fail

Tamarack Outfitters earned 480 in 2025. Its cash rose by only 40. The two numbers are both true, and neither is a mistake: net income is built on accrual accounting — revenue when earned, expenses when incurred, depreciation spread over years — while cash is what is actually in the bank. A company pays wages, suppliers, interest and the loan principal in cash, not in net income. Stakeholders watch the cash-flow statement for three things the income statement cannot tell them: liquidity (can it pay this year’s bills), solvency (can it service its debt over the long run) and flexibility (can it seize an opportunity or survive a shock without borrowing at any price). The cash-flow statement is also the check on the quality of earnings: profit that never turns into cash — because customers are not paying or inventory is not selling — is profit a reader should discount.

The three activities

Every cash movement in a year is sorted into one of three sections:

• Operating — cash from the business the company is in: collections from customers, payments to suppliers and employees, interest and taxes (on the course’s default placement, lesson 10.3). This is the section that must be positive over time.
• Investing — cash spent on, or recovered from, long-lived assets and investments: buying and selling PP&E, buying and selling shares of other companies, making and collecting loans to others.
• Financing — cash from, and returned to, the providers of capital: borrowing and repaying principal, issuing and buying back shares, paying dividends.

Twelve Tamarack items

Collections from customers                    operating   inflow
Payments to suppliers for inventory           operating   outflow
Wages paid                                    operating   outflow
Income tax paid                               operating   outflow
Interest paid on the term loan                operating   outflow (course default)
Purchase of store fixtures                    investing   outflow
Proceeds from selling an old delivery van     investing   inflow
Purchase of a competitor’s shares             investing   outflow
New term-loan borrowing                       financing   inflow
Repayment of loan principal                   financing   outflow
Dividends paid to shareholders                financing   outflow (course default)
Shares issued for cash                        financing   inflow

Two items that are not on the list are the ones the exam uses as traps. Depreciation is not a cash flow at all — no cash moves when an asset is depreciated — so it appears in the statement only as an adjustment inside the indirect operating section (lesson 10.2), never as an outflow. And a gain on the sale of the van is not the cash either: the cash is the proceeds, in investing; the gain is an accounting difference that the operating section has to remove.

Non-cash investing and financing

Suppose Tamarack acquired a warehouse site by issuing shares directly to the vendor. Economically the company both invested (it has land) and financed (it issued shares), but no cash moved, so the transaction appears in neither section. It is disclosed in a note or a supplementary schedule to the statement, so a reader who compares this year’s PP&E and share capital with last year’s can see why both jumped without any cash flow. The same treatment applies to converting a bond into shares, or acquiring equipment under a lease. The test is always the same question: did cash change hands?

Profit ≠ cash, in one example

A start-up sells 100,000 of goods in December on 60-day terms, having paid 70,000 for the goods in November. Its December income statement shows a 30,000 profit; its December cash-flow statement shows 70,000 going out and nothing coming in. In January it must still pay its staff. Growth consumes cash before it produces it — which is why a fast-growing profitable company is the classic case that runs out of money, and why lesson 10.4 reads the working-capital lines before believing the net income.