What it means
Accounting profit is calculated on the accruals basis, meaning income and costs are recorded when they are earned or incurred rather than when cash moves. That is the right way to measure performance, but it means the profit figure includes charges such as depreciation that reduce profit without any payment being made.
Cash profit adds those non cash charges back. The most common are depreciation of equipment, amortisation of intangible assets, increases in bad debt or warranty provisions, and the accounting cost of share based payments to staff.
The measure matters most in capital intensive businesses. A haulage firm or a hotel group can report a modest profit while generating far more cash, simply because heavy depreciation on assets bought years ago sits between the two figures.
It is not the same as operating cash flow, and treating it as such is the usual error. Operating cash flow also reflects money absorbed by rising stock and receivables, so a business with strong cash profit and a fast growing debtor book can still see its bank balance fall.
Lenders often use a close relative of cash profit, earnings before interest, tax, depreciation and amortisation, as the base for covenant tests. Understanding how the adjustments are built helps managers see why a bank looks past a statutory loss caused mostly by write downs.
In practice
Real-world examples.
Example
A gym chain reports a statutory loss of $180,000 after $940,000 of depreciation on fit outs and equipment. Its cash profit of $760,000 is what persuades its bank that the business services its debt without difficulty.
Example
A media agency writes off $400,000 of goodwill from an earlier acquisition. Profit falls sharply, but because the write down moved no money, cash profit is unchanged and the partners' distribution policy stays intact.
Example
A vehicle leasing company compares cash profit with reported profit every quarter. When the gap narrows sharply one quarter, it turns out an unusually large disposal gain had inflated profit, prompting a closer look at the underlying rental performance.
Think of it
“Cash profit is accounting profit adjusted for non-cash items-a simplified cash earnings measure.
Formula
Calculation
Cash profit = profit after tax + depreciation + amortisation + other non cash charges
A packaging manufacturer reports profit after tax of $480,000 for the year. Its accounts include depreciation of $310,000, amortisation of purchased software of $60,000, and a $25,000 increase in its warranty provision that has not yet been paid out.
Cash profit = $480,000 + $310,000 + $60,000 + $25,000 = $875,000.
To bridge from there to operating cash flow, the company also has to fund working capital. Stock rose by $120,000 and receivables by $150,000 while payables rose by $70,000, a net absorption of $120,000 + $150,000 - $70,000 = $200,000. Operating cash flow is therefore $875,000 - $200,000 = $675,000, comfortably above the reported profit but well below the cash profit figure.Case study
Seen in the real world.
The following is an illustrative and clearly fictional story. Ardenhall Coaches, an invented operator of 40 vehicles, presented accounts showing profit after tax of just $95,000 and a worried board began discussing whether to sell the business. Depreciation on the fleet was $1,050,000 a year, and nobody at the table had separated that charge from the cash reality.
The fictional finance manager reworked the numbers as cash profit: $95,000 + $1,050,000 of depreciation + $40,000 of provision increases = $1,185,000. Against annual loan repayments of $620,000 and a replacement vehicle budget of $450,000, the business was funding itself with $115,000 to spare.
The board's conclusion changed completely. Rather than selling, Ardenhall extended the replacement cycle for its lowest mileage coaches by two years, which reduced the depreciation charge, and used the illustrative cash profit figure as the headline measure in its monthly reporting pack.
Watch out
Common mistakes.
- Using cash profit as though it were operating cash flow and ignoring the money absorbed by growing stock and unpaid customer invoices.
- Adding back depreciation and then forgetting that the assets still have to be replaced, which makes a capital intensive business look far more cash generative than it is.
- Adding back every unusual item as though it were non cash, when redundancy costs and legal settlements are usually paid in full and belong in the calculation.
Questions
People also ask.
Is cash profit the same as EBITDA?
They are close cousins, but EBITDA also adds back interest and tax, whereas cash profit as normally defined starts from profit after both.
Why do lenders care about it?
Because interest and capital repayments are made in cash, so a measure that removes accounting charges gives a better view of a borrower's capacity to service debt.
Does a business with high cash profit always have cash in the bank?
No, since the money can be absorbed by working capital, capital expenditure, tax payments and dividends before it ever settles as a balance.
From the founder's library
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