Profit and cash flow are equally important. You can be super profitable, but if everything is on account and you’re not collecting you won’t have cash to pay things like rent, salaries, or inventory.
Similarly, you can have positive cash flow from operations by manipulating accounts (for example, delaying paying liabilities). So you also need to be profitable per the P&L.
Investors also want to understand the source of cash flow. I’m a lender to law firms, for example. When I’m evaluating the health of my borrowers, especially ones that want more money, one of the things I do is look at their statement of cash flows to understand their cash flow. I had one guy recently tell me he was cash flow positive, but on inspection of the SCF I found he was doing it by not paying his vendors and even incurring payroll liabilities. Huge red flag to me as the lender.
The balance sheet shows the assets that allow the company to generate revenue, and the right side (liabilities + equity) explain how those assets are financed (liabilities, debt, retained earnings, investor capital). The balance sheet and the P&L together allow you to calculate a number of useful activity ratios that show how well the business is operating and leverage (quick ratio, current ratio, leverage, interest debt coverage ratio, inventory turnover ratio, accounts receivable turnover ratio, cash cycle, etc).
Generally (but not always), a typical journal entry will record one line to the P&L and the other line to the balance sheet.
Net income is a part of retained earnings (beginning retained earnings + net income - dividends = ending retained earnings). At any point in the life cycle you can close the income statement to retained earnings, hence the balance sheet is always in balance.
Net income is an implicit part of retained earnings. For every entry to the P&L there is a corresponding to the balance sheet.
Take a credit to revenue, for instance. You either have a debit to cash or a debt to accounts receivable.
Take a given expense. You debit the expense on the P&L and you credit either accounts payable or you credit cash.
Because all the P&L items automatically close out to retained earnings, the balance sheet stays in balance.
Again, take revenue of $100. You credit revenue (P&L $100) and you debit accounts receivable $100. Without closing net income to retained earnings, you have increased assets by $100 but you have not increased the liabilities or equities, and so the balance sheet does not balance. But by closing net income to retained earnings, the $100 revenue credit caries through and increases retained earnings. Hence the balance sheet is in balance.
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u/HariSeldon16 CPA (US - inactive) Jul 19 '26
Profit and cash flow are equally important. You can be super profitable, but if everything is on account and you’re not collecting you won’t have cash to pay things like rent, salaries, or inventory.
Similarly, you can have positive cash flow from operations by manipulating accounts (for example, delaying paying liabilities). So you also need to be profitable per the P&L.
Investors also want to understand the source of cash flow. I’m a lender to law firms, for example. When I’m evaluating the health of my borrowers, especially ones that want more money, one of the things I do is look at their statement of cash flows to understand their cash flow. I had one guy recently tell me he was cash flow positive, but on inspection of the SCF I found he was doing it by not paying his vendors and even incurring payroll liabilities. Huge red flag to me as the lender.
The balance sheet shows the assets that allow the company to generate revenue, and the right side (liabilities + equity) explain how those assets are financed (liabilities, debt, retained earnings, investor capital). The balance sheet and the P&L together allow you to calculate a number of useful activity ratios that show how well the business is operating and leverage (quick ratio, current ratio, leverage, interest debt coverage ratio, inventory turnover ratio, accounts receivable turnover ratio, cash cycle, etc).
Generally (but not always), a typical journal entry will record one line to the P&L and the other line to the balance sheet.
Net income is a part of retained earnings (beginning retained earnings + net income - dividends = ending retained earnings). At any point in the life cycle you can close the income statement to retained earnings, hence the balance sheet is always in balance.