Converting Profit to Cash Flow

If you keep your books on the accrual method of accounting, you'll have to make some adjustments to determine your actual cash flow. These adjustments are necessary because certain expenses are taken into account to determine your accrual net profit, even though these expenses do not currently require a cash outlay. To convert your accrual profit to your cash flow profit, you need a balance sheet

for the beginning and end of the period under examination.

As a general rule, you can convert your accrual net profit using the following formula:

Net Profit
+ Depreciation
- Increases (or + Decreases) in Accounts Receivable
- Increases (or + Decreases) in Inventories
+ Increases (or - Decreases) in Accounts Payable
- Decreases (or + Increases) in Notes Payable (Bank Loans)
= Net Cash Flow

Depreciation and cash flow. Depreciation is an expense deducted from your business income to reflect the annual cost of assets used in your business. Since the depreciation deduction is purely a "paper" expense, it requires no cash outflow. If you use the accrual method of accounting, depreciation must be added back to your accrual net profit to determine your cash flow profit