Profit versus cash

The most important number for any business is cash flow. Without cash, a company won’t be in business for long.

Yet most business owners focus on two other metrics: profit and the current cash balance in the bank.

Profit is revenue minus expenses.

The current cash balance is beginning cash plus cash inflows minus cash outflows.

Many business owners are surprised, especially around tax time, to discover that there can be very little correlation between profit and cash.

Not all cash deposits are revenue, and not all cash expenditures are expenses.

The money you invest into (contribute) to the business, and the cash you draw out (distribute), don’t affect profit. These affect your equity in the company, which is reported on the balance sheet, not the profit and loss statement.

Assets, such as equipment, office furniture, and vehicles, are also reported on the balance sheet and not as expenses when purchased. You can expense assets over time—usually a number of years, depending on the expected life of the asset—through depreciation.

If you use debt—mortgages, loans, lines of credit, or credit cards—to buy assets or fund operations, the principal portion of the payments is an expenditure but not an expense. Interest paid on debt is an expense.

Lots of cash flow activity can occur without being reported on the P&L. That’s why it’s important you also read and understand your balance sheet.

There’s also a statement of cash flows that summarizes all the cash deposits and expenditures that aren’t revenue or expenses. This helps you track where your cash came from and went.

So let me know…

Do you manage and forecast your cash flow on a regular basis?

Could your company handle an unexpected fluctuation in cash flow?

How do you ensure that your business has sufficient cash on hand to pay its bills and invest in opportunities?

Hit REPLY and tell me about it!