In plain English
A business buys things, turns them into something people want, and sells them for more than they cost. What customers pay is revenue. What the business spends is cost. Revenue minus cost is profit. Cash is the actual money in the bank account, and it is not the same thing as profit — you can be profitable and still run out of money.
The advanced view
A firm is a bundle of contracts financed by two classes of claim: debt, which is paid first and by a fixed amount, and equity, which is paid last and gets whatever remains. Accounting profit measures value created in a period under accrual rules; cash flow measures settlement. The gap between them is timing, and timing is what kills otherwise healthy companies.
Start with a lemonade stand. You buy lemons and sugar for 40, you sell drinks for 100. Revenue is 100, cost is 40, profit is 60. That is the whole of accounting in one line — everything that follows is detail about when to count things and where to record them.
Two groups put money into a business. Lenders (the bank, bondholders) hand over money and want it back with interest, whatever happens. Owners (shareholders) put money in and get whatever is left after everyone else is paid. That is the whole reason the balance sheet is shaped the way it is: assets on one side, and on the other side the two groups with a claim on them.
Profit and cash come apart as soon as you let a customer pay later, or you pay a supplier later, or you buy a machine that lasts five years. Nothing dishonest is happening — the accounts are simply matching effort to the period that earned it, while the bank account only knows about money that actually moved.
The three lines to memorise
Profit = Revenue − Costs Assets = Liabilities + Equity Cash at end = Cash at start + Cash in − Cash out
Essential vocabulary
- Revenue
- What customers were charged in the period. Also called sales or turnover. Not the same as cash received.
- Cost
- What was used up to earn that revenue — materials, wages, rent, and a slice of the cost of long-lived equipment.
- Profit
- Revenue minus cost. Also called earnings or net income when it is the bottom line after tax and interest.
- Cash
- Money actually in the bank right now. The only thing you can pay wages with.
- Equity
- What the owners would be left with if every asset were sold at book value and every debt repaid.
- Debt
- Money borrowed. Paid back on a schedule with interest, before owners get anything.
Common pitfalls
- ×Treating profit and cash as the same number. They almost never are.
- ×Calling money received in advance 'revenue'. Until the work is done it is a liability.
- ×Forgetting that owners are paid last — a company can be worth nothing to shareholders while still paying its lenders in full.
Why it works
Every transaction has two sides: a source of money and a use of it. That is why the balance sheet balances — not as a rule someone invented, but because you cannot own something without either having borrowed for it or funded it yourself. Once you believe that identity, every ratio built on top of it is exact rather than approximate.
How it is used — profit and cash from the same month
Step 1 of 5
- 1You sell 100 of drinks; 60 in cash, 40 on credit (paid next month).
Deeper
Deeper: the difference between profit, cash and value
Three numbers describe the same business and almost never agree. Profit is an accounting opinion about a period: revenue earned minus the costs matched to it. Cash is a fact: what actually moved through the bank account. Value is a forecast: what all the future cash is worth today, discounted for time and risk.
Most business mistakes come from confusing them. A company can be profitable and run out of cash (growth soaking up receivables and inventory), cash-rich and worthless (a melting ice cube harvesting an old asset base), or loss-making and extremely valuable (a subscription business paying acquisition cost up front for years of margin).
Must know cold
- ✓Profit = revenue − costs. Cash = money in − money out. They differ because of timing.
- ✓Value = the present value of future cash flows, not last year's profit.
- ✓Margin = profit ÷ revenue. Every margin is 'per 100 of sales'.
- ✓Fixed costs do not move with volume; variable costs do. That distinction drives break-even.
More vocabulary
- Contribution margin
- Price minus variable cost per unit. What each extra sale contributes to covering fixed cost.
- Break-even volume
- Fixed cost ÷ contribution margin. The volume at which profit is zero.
- Operating leverage
- The share of cost that is fixed. High fixed cost means profit swings hard with volume.
Exercises
Try each one on paper before revealing the worked solution.
Exercise 1
A café sells coffee at 40 SEK. Beans, milk and cup cost 12 SEK. Rent and staff cost 84,000 SEK a month. How many cups a month break even, and what is the profit at 4,000 cups?
Exercise 2
The same café is offered a catering contract: 1,000 cups at 25 SEK, no extra fixed cost. Should it take it, and what changes the answer?