A common question we are asked as accountants is “where is my profit?”
What the client is really asking is: “where has the cash gone?” a reflection on the small business owner’s propensity to focus on the bank statement, not on net equity (assets less liabilities).
So where does the profit go? You have prepared a profit and loss statement for your business, and it shows a healthy profit (and thus, a tax bill), why hasn’t the bank balance improved?
Well the answer lies in what we call balance sheet transactions, debits on your bank statement that aren’t necessarily deductions. For example:
- Creditor payments – reduce debts but are not a deduction;
- Loan repayments – reduce debt but are not a deduction;
- Capital purchases – you buy a car or a building, it increases your assets, but the payment is not a deduction;
These are “good” payments in that they serve to improve net equity but do not reduce your profit amount.
Another example, where you record profit but no cash, is:
- Sales on account – increases your profit but if cash is not received, bank will suffer.
And more commonly, transactions which just reduce bank but aren’t deductions OR equity improvements:
- Profit drawings – owner takes a regular drawing for themselves; it reduces your bank but is not an expense.
So, net profit will not always equal movement in the bank balance – in fact hardly ever. It is important therefore to not only operate at a profit BUT also to manage cash flow.
- Watch your debtors to make sure they pay on time;
- Manage your creditor payments, take advantage of their generosity if you can;
- Manage bank debt repayments; they can be negotiated to be as flexible as you like;
- Control your drawings; if the money is not there be careful
But out of curiosity, don’t just ask your accountant to prepare the standard profit and loss / balance sheet / tax return. Ask him or her to prepare a cash flow statement as well so you can see where your cash, and your profit, is going!
Disclaimer: This article contains general information. Before you make any financial or investment decision you should seek professional advice to take into account your individual objectives, financial situation and individual needs.