Question

Is it possible for a firm to have a positive profit and yet have a negative cash flow? Describe a scenario under which this might occur? Where does the money from profits go in such a case?

Answer 1

The answer to the above question is 'Yes'. It is quite possible that a firm may post a positive profit in profit and loss statement, however the cash flow shows negative cash flows. The primary reason behind the same is the accounting treatment and accounting policies on the basis of which most of the companies accounts their profits. Based on GAAP, a firm has to recognize profits in the profit and loss statement, even if it is not realized in the particular year, so that proper representation of the profit accrued during the year can be made. For example, if a company holds a long term asset like land, and the price of such land has gone up in the market during the year, the increase in price should be recognized in the profit and loss account as a profit. However, there is no realization of such profit, the profit just accrued and not realized, therefore the same will not reflect in the cash flow (because cash flow statement only includes real cash receipts and outgo) but will be shown in the profit and loss account. Hence, the money does not go anywhere, in reality the money was not actually received to be shown in cash flow statement that is why it has shown negative cash flows and positive profits.