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Why Profit Doesn’t Always Mean Cash

Article written by Veechi Curtis

I can’t believe how often clients ask, ‘Veechi, my reports say I’m making fistfuls of cash, but how come there’s nothing in the bank?’ Similarly, I occasionally witness clients who are wallowing in cash and living the high life, even though their Profit & Loss reports are decidedly gloomy.

Remember:The long and short of it all — profit doesn’t equal cash and cash doesn’t equal profit.

So why is it that your Profit & Loss reports say you’re doing well but there’s no cash anywhere to be seen? I set out a few possible explanations here:

  • You’ve been paying tax: A tricky habit to avoid (do tell me if you discover how), but the truth is that as soon as you make any profit, you have to pay tax. (Tax payments don’t usually show up in Profit & Loss reports because, cruelly enough, they’re not a tax-deductible expense.)
  • You’ve bought new equipment: As you probably know already, any new gear that costs more than a certain amount (between $100 and $1,000 depending on whether you live in Australia or New Zealand and what system you’ve elected to be in — see Chapter 13 of Small Business For Dummies for details) isn’t immediately tax-deductible and so doesn’t show up as an expense, but gets listed as an asset instead.
  • You have teenagers: The most merciless financial cash drain on any individual.
  • You repaid a loan: Loan repayments don’t usually show up as expenses, meaning that loan repayments gobble up cash but don’t affect your profit.  You’re owed heaps: If you bill a customer in April, your Profit & Loss reports show this income in April, even though you may not actually receive the cash until weeks or months later. Therefore, if customers owe you more now in total than they did six months or so ago then, consequently, this difference has sucked up your cash.

What about the opposite scenario, where a business is rolling in cash but the Profit & Loss reports look decidedly gloomy? In many ways, this situation is even worse, because you can all too easily get lulled into a false sense of security, spending beyond your means.

Here are some reasons why cash might be rosy but your profit grim:

  • You receive a loan: Loans are both a blessing and a curse. When you receive a loan, the sudden influx of cash can burn a hole in the thickest of pockets.
  • Your creditors are building up: You can actually get by for quite a while making a loss but staying afloat, simply by running up outstanding accounts. If you start to stretch out suppliers to 60, 90 or even 120 days, you not only generate a fair amount of bad feeling, but wads of cash also.
  • You’re running stock down: If your stock levels go down, you have more cash available. Simple as that.
Small Business For Dummies

For more about understanding your small business finances, as well as managing budgets and cashflow, you can purchase your own copy of Small Business For Dummies from our online bookstore.

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