Thread by @Jarushub

1/ A company can be cash generating and making losses.

Another company can be profit making and having dire cash situation.

Here is why:

Profit = Revenue - Expenses

Where Expense > Revenue, you have a loss.

Understanding what is revenue and expense is not as

2/ straightforward as people (especially non-accountants) think.

Revenue is not simply the cash you collected from your sales as people think. Let me spare you the accounting jargon called “principles of recognition of revenue”, but present only one interesting aspect of

3/ what is recorded as revenue: once that sale transaction is completed and both buyers and sellers fulfill some conditions (eg buyer accepts delivery of the goods), the seller can record revenue in his books, even if their contract says he will be paid cash next year.

4/You see something that is included in revenue today and not cash today. That’s scenario 1, which simply means credit sale is still a revenue despite no cash yet.

Scenario 2: you can actually have received the cash for a “sale” but you can’t record it as revenue yet

5/ This is the case with someone paying you money well in advance for something you have not delivered or certain other contractual conditions have not been met. That is called deferred revenue - you can’t record it as part of your revenue. Rather, it is a Balance Sheet item,

6/ actually a liability to you (because you have collected money for an obligation you are yet to carry out). An example here is that advance money you pay to real estate developer. Even though he has the cash, that cash is not revenue to him yet until the house is delivered or

7/ some contractual milestones met.

In the first scenario, you can see why someone can have high revenue (and profit) despite not having the cash yet.

In the second scenario, you can see why someone can have big cash, but low revenue (hence loss yet).

8/ Those first two scenarios are from revenue side of the profit/loss equation, let me paint two more scenarios from the expense side.

Scenario 3: there are some expenses that are called capital expenditure. They are not totally recorded as “expense” to be deducted from revenue

9/ in the year you spend the cash. For example, a plant you bought for N400m is to be depreciated over 10 years. What that means is that even though you spent N400m cash in year 1, you will record only N40m per year as your expense (ie N400m/10 years).

10/ What the above means is that, even though there is a major reduction in your cash (N400m) in that first year, you can only record N40m as your expense for that year. So you have “lost” heavy cash in that year, but the expense is not big. That will make you have low cash but

11/ high profits (because only N40m rather than N400m is deducted from your revenue to arrive at profit) for that year.

Scenario 4: Drawing from scenario 3, the cash has gone out in first year right? But N40m will be recorded as expense every year for 10 years, even though

12/ no N40m cash is going out from your account from years 2 to 10. You can see “increase” of N40m to your expense in each of those years without any N40m going out of cash. Increase in expense means lower profits, and if your revenue is low, it could throw you into loss,

13/ despite the fact that you are not losing cash.

Scenario 4 is called depreciation, a non-cash expense (well, the cash had been spent in the past). Other non-cash expenses include write-off of bad debt (eg someone was owing you N10m for say 5 years and after evaluating the

14/ chance of recovery, you realized you can’t recover it again, you write-off that debt). Anytime you hear write-off, it means that thing has been treated as an expense (even though you did mot spend cash). If a car of N40m meant to be depreciated at N10m each year for 4 years

15/ had an accident after 1st year and is “written off”, it simply means the remaining N30m (meant to be spread as expense for 3 years) will now be totally taken as expense in that accident year (year 2). That’s a big expense for that year (and could lead to loss) despite the

16/ fact that it is not that they spent N30m cash that year.

Profit or loss is recorded on yearly basis ie revenue and expense are compared each year to arrive at profit or loss for that year.

17/ In summary:

Scenario 1 shows you can have high revenue (and profit), but no cash because that “revenue” will not turn to cash until next year.

18/ Scenario 2 shows you can have cash (received from customer in advance), but not yet a revenue to you (so you can still keep that cash even if other factors put you in loss making position now).

19/ Scenario 3 shows you can have low cash (eg after draining your cash to fund a plant acquisition) but still make profits (ie low expense)

20/ Scenario 4 shows you can have big expenses and be making loss (because of high non-cash expenses like depreciation, write-offs etc) without lowering your cash in that period.

21/ Combination of scenarios 1 ( revenue wey never turn cash) and 3 (spending current cash in capex) can spell doom for a profit making company in the short term.

22/ Many companies do not mind scenario 2 (customers paying in advance eg real estate developers and similar business models). Profit is good, but cash is king!