Why am I seeing profit but have no cash in my bank account? If you find yourself asking this when you’re looking at your profit and loss statement, you’re not alone.
However, there’s no need to feel like you’re on the losing side of the equation.
Resolving this challenge means understanding the full picture of your financial standing across three key reports: balance sheets, cash flow statements, AND profit and loss.
Even if you don’t need to understand all the complexities, what you do need to understand is simply this:
Not all cash-out transactions hit your profit and loss report. Some hit your balance sheet.
A range of transactions falls in this bracket of affecting your cash flow without you being aware.
Usually, though, it boils down to the following five most common cash consumption items that don’t appear on your profit and loss statement:
1. Owner Draws
An owner’s draw is money business owners take out of the business, usually by check. This is recorded in the equity section of the balance sheet.
Sole proprietors, LLC owners, Partnership owners, and S-Corp owners are allowed to take draws from their business. C-corps are not.
This type of reduction is taken from your owner’s equity, which is an item that appears solely on the balance sheet. Many business owners use draws to pay themselves (as an alternative to a salary) or for other personal use.
2. Loan Payments
Loan payments may also camouflage your cash. The principal repayment does not appear on your profit and loss, whereas the interest expense does. So while your interest payments will lower your profit, your larger loan payments won’t.
This principal portion reduces the liability on the balance sheet only, and, of course, decreases your cash flow.
3. Asset Purchases
Asset purchases are another line item that pulls from your cash balance with no immediate reflection on your profit and loss balance.
When you purchase a big asset such as a vehicle, instead of registering it as a one-time expense, you (or your bookkeeper) gradually record a depreciation expense over the life of the asset.
Any portion of the asset initially paid for with cash, as opposed to financing, is recorded in the fixed assets section of the balance sheet.
4. Inventory Purchases
Inventory is recorded as a current asset on your balance sheet. You only see the profit from the inventory you sell in a given reporting period.
So, for instance, if you purchase $1,500 worth of goods but make only $250 in sales, you’d see a decrease in cash of $1,250 overall, and an increase in profit of $250.
Remember, your current assets are what can quickly be turned into cash. Inventory is an increase in your assets despite you having to dish out cash to attain it in the first place.
5. Prepaid Expenses
These can be confusing. You record — and pay upfront — certain expenses in your balance sheet, but record them as you would normally use them in the profit and loss sheet.
- Prepaid rent
- Prepaid insurance
- Prepaid interest
You pay out the amount required to gain the benefit up front, and will consume these benefits over a given period.
Companies typically work like this to reduce the risk of loss on their part, requiring contractual obligations for their services.
The portion of the service you typically use during a reporting period is what you record in your profit and loss. For example, you may pay rent for six months, yet you’ll record only one month at a time in your profit and loss as an expense.
The full cash paid out will show up in your balance sheet and cash flow statement.
Cash Vs Accrual Accounting Methods
Most businesses adopt the accrual accounting method as opposed to the cash method. The latter requires you to record income and deduct expenses in the accounting period you incur them.
In contrast, the accrual method means you record activities whenever you send out or receive a document.
For example, using the accrual method, when you send out your invoice to people who owe you money and record the income you expect from them even though they have 30 days to pay.
Likewise, when you receive a bill, you record it as an expense even if you don’t make the payment right away.
Focus More On Your Cash Flow & Less On Your Profit And Loss
Your profit and loss has an important place. It shows you where you might decrease expenses to increase profit or reduce loss, is necessary for tax purposes, and convinces financial institutions you’re a viable business worth investing in.
Ultimately, though, it’s essential to maintain focus on your cash flow so you’re not blindsided by a cash shortage when the end of a financial period comes around.
You can encourage the movement of your cash flow by:
1. Following up on overdue payments from debtors
2. Taking advantage of supplier credit so you can pay for stock AFTER it’s sold.
3. Keeping cash reserves in place for when emergencies come up.
All of these are also listed out in your balance sheet, so you regularly want to glance over there to get the fullest picture of your financial standing.
Profit Does Not Equal Cash
Now that you’ve seen through the illusion, you can understand the accounting phrase: Profit does not equal cash (flow). More importantly, you now have a better understanding of how to boost your cash flow.
Together, your balance sheet and cash flow statement should clear up any confusion about where your cash is going so that you have a clear understanding of your financial standing and are in a better position to grow..
And if you’d like help compiling any of these vital accounting statements or need deeper, meaningful insights into the story your financial information tells, book a free consultation call with us!