Question

The Directors of Rima Ltd had carefully monitored the cash position over the past financial year, and were pleased to note at the end of the year that the cash position was strong, and had shown a healthy 50% increase over the year. When presented with the Statement of Profit or Loss for the year, they were dismayed to note that profit had deteriorated significantly. In their anger, they accuse you of having made errors in the accounting since 'such a silly situation could not possibly exist'. Required Explain how you would respond to the Directors.

Answer 1

There should not be any mixing between cash balance and year-end profit, since there calculations are different.

Cash book is prepared for cash balance income statement is prepared for profit. There are so many activities highlighted in the cash book – operating activities, investing activities, and financing activities – any sorts of collection and disbursements of cash during the period are entered there.

Income statement (or profit or loss statement), on the other hand, only considers all sorts of incomes, expenses, gains, and losses during the period. Suppose an old machine that has book value of $45,000 is sold through cash in the market at $50,000; therefore, there is a gain of (50,000 – 45,000 =) $5,000 that is to be recorded in the profit or loss statement but in the cash book the whole $50,000 should be recorded as incoming of cash; by this effect, cash balance becomes ($50,000 / $5,000 =) 10 times higher than profit.

These are the reasons why cash balance and profit don’t agree and there is no silly.