It can be confusing when a business is displaying a nice healthy profit on paper, but not showing much cash in the bank. The business owner might be wondering why they’ve got no money when their business is apparently doing so well!
This type of scenario demonstrates the importance of understanding the difference between profit and cashflow when running a business.
What is profit?
A profit occurs where the revenue that comes into your business from its activities is higher than the costs that go out of it.
Any profit made in your business will show up on the profit & loss (P&L) report, sometimes called an income statement. The P&L report is a snapshot of your business’s revenue and expenses for a given period.
However, the P&L also includes revenue generated but not yet received (or ‘realised’ to use an accounting term), and any bills you’ve recorded in your system but not yet paid.
So, you might for instance have sent out 50 invoices this month, but only ten customers have actually paid. On the other side of the ledger, you might have recorded an electricity bill and a phone bill you’ve received but you plan on paying next month. All of these items will be reflected in the P&L.
What about cashflow?
Cashflow differs from profit in that it refers to the cash that literally flows in and out of your business. So, in the above scenario, your incoming cash would include those ten customers who have already paid, but not the 40 who haven’t.
This is one of the reasons that your cash balance may differ from the profit your business is showing. There are other reasons that the two could differ as well though – such as your previous bank balance, finance you’ve received (e.g. a bank loan), any sale of assets and so on.
Which is more important?
Both of these metrics are important in a business. Without cash in the bank, you could struggle to meet your commitments, such as wages, supplier payments, taxes and loan repayments.
Profit enables you to make business growth decisions – e.g. such as whether to invest in new equipment, or to expand your product range.
Tips for improving your cashflow
If you do find your business is showing a profit but that you’re frequently scrounging to pay wages each fortnight or your bills each month, you should look into improving your cashflow.
This might mean:
Creating budgets, cashflow forecasts and cash safety nets.
Tightening up the terms on debtor invoices.
Chasing up outstanding debtor invoices.
Staggering bill payments.
Doing an overview of your inventory. For example, you might find you have too much cash tied up in slow-moving items.
In any case, it’s very important to keep up with your bookkeeping! Failure to do so means you won’t have a clear picture of the health of either your profit or cashflow. That said, many business owners just don’t have the time or skills to manage their own bookkeeping, and may choose to partner with a bookkeeping firm instead.
At Bookit, we provide a dedicated account manager for each client and our services cover the full 52 weeks of the year. To find out how you can benefit from partnering with us, get in touch for a chat.