A quick question on Net Profit.

chris.p.chris.p. Just JoinedPosts: 4Registered
Hi all

If I do a Bootfair and have Sales of £50.
Cost of Sales is £10
Gross Profit is £40

Cost of table at Bootfair is £10
Depreciation on the van (to get to Bootfair) is £10
Net Profit is £20

My question is if my Net Profit is £20, why do I have £30 cash in my pocket ?

Thanks for your replies.

Chris.

Comments

  • amyjayne27amyjayne27 Trusted Regular Posts: 314Registered
    Hi Chris,

    I think it because of the depreciation at £10. Depreciation is not a cash expense but needs to be accounted for, hence why you have the extra £10 in your pocket.

    Hope this helps
  • chris.p.chris.p. Just Joined Posts: 4Registered
    Thanks for the reply Amy.

    I think my question is why have a Net Profit for a business that is less than the actual cash you have?

    Thanks

    Chris
  • amyjayne27amyjayne27 Trusted Regular Posts: 314Registered
    I see what you're saying but it is again because of non cash expenses. These figures are important and need to be accounted for, but as they are not physical amounts of money, what you have in your pocket will be different to the net figure shown.

    If you didn't include non cash expenses such as depreciation the accounts would not reflect the true situation of your business.

    Really sorry if I don't make sense, it makes sense in my head! :-)
  • MarieNoelleMarieNoelle Trusted Regular Hampshire/Surrey borderPosts: 1,461Moderator, MAAT, AAT Licensed Accountant
    Hi chris.p.,

    I think you may be confusing profit and cash. Your profit is based on an accrual basis and a more conservative approach.

    Here you account for depreciation (a non-cash expense) because you know that in 5 years-time your van will be worth a lot less and you may have to buy a new one. When it comes to sell your van you will deduct the depreciation from the original value of your van and you will therefore make a smaller loss.
    Depreciation in effect helps you spread the cost of your van over the years and make your profit more "even".
    As amyjane said, your profit is a truer reflection of your business than the cash you have in the bank.
  • stevefstevef Well-Known CarmarthenPosts: 258Registered
    Thinking of depreciation as a way of putting money aside to help pay for a replacement vehicle. So you have £10 in your pocket, but you have warn van out by £10, you are going to need that £10 when you replace the van, you need to hang on to it for a later payment. Similar arguments can be applied to most non cash expenses.
  • chris.p.chris.p. Just Joined Posts: 4Registered
    Thank you all very much for your replies.

    If I may refine my question A bit more.

    I still don't see the point of Depreciation and deducting it from the Profit a business makes.
    The cash is spent when you buy the asset, why pretend it is being spent over the useful life of the asset.

    There's something I'm missing about Depreciation.

    Chris.
  • Diddy MauDiddy Mau Well-Known Posts: 238Registered
    chris.p. wrote: »
    I still don't see the point of Depreciation and deducting it from the Profit a business makes.
    The cash is spent when you buy the asset, why pretend it is being spent over the useful life of the asset.

    There's something I'm missing about Depreciation.

    Chris.

    Hi Chris,

    The van is an asset to the business and sits on the balance sheet not the p&l account. So the van affects the B/S
    If the company stops trading, then the asset is sold. the depreciation shows how much this should be worth if sold.

    Hope this helps,
  • coojeecoojee Experienced Mentor Posts: 794Registered
    chris.p. wrote: »
    Thank you all very much for your replies.

    If I may refine my question A bit more.

    I still don't see the point of Depreciation and deducting it from the Profit a business makes.
    The cash is spent when you buy the asset, why pretend it is being spent over the useful life of the asset.

    There's something I'm missing about Depreciation.

    Chris.

    If you were going to do it this way (everything on a cash basis) then you'd have to deduct the whole cost of the van to arrive at your profit. Now all of a sudden your £30 cash in the pocket becomes a loss of £14,970 (assuming the van cost £15000)
  • crispycrispy Trusted Regular SouthamptonPosts: 454Registered
    As above, the purpose of the depreciation charge in the accounts is to spread the cost of the asset over it's useful economic life.
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