When business owners receive their financial statements, the almost immediate response is to look and ask for three things:
- How much profit did I make?
- How much tax do I owe?
- How can I have made a profit but have so little cash?
Whilst this blog won’t dive into the topic of taxes, you will hopefully takeaway a greater understanding of the relationship between profit and cash, how each is calculated and how the two can interact with each other.
What is Profit?
Profit is typically defined as the difference that remains when all of a businesses operating expenses are subtracted from its revenues. It’s what’s left when the books are balanced, and expenses are taken away from proceeds. A business cannot survive in the long term unless it is profitable. Profits are usually distributed to the owners and shareholders of a company, often via dividend payments, or can be retained to be reinvested back into the company.
What is Cash?
Cash flow measures the ability of the company to pay its bills and impacts how much money there is available at any given time. The cash balance is the cash received minus the cash paid out during the time period. When a business purchases stock or materials, for example, money flows out of the business toward its suppliers. When that same business sells their stock or services, cash flows into the business from its customers. If cash on hand is negative, the company has spent more cash than it has brought in during that time period.
How do Profit and Cash interact?
Accountants generally prepare financial statements using the accrual basis of accounting. This method basically refers to income and expenditure being reported when they are incurred as opposed to when they are actually paid.
For instance, you may issue an invoice to a customer on 1st March however they may only make payment on 30th April. If you have an accounting period that ends on 31st March, the revenue from the invoice issued would be recorded in that accounting period, however you would have only received the payment in the following period.
This is a key example as to how profit interacts and can differ from your cash balance. In this example, the revenue will be recorded, and therefore your profit increases for the year, however as the payment comes in after the end of the year, your cash balance does not reflect this in the financial statements.
A state of quick or unexpected growth can cause a problem with either profit or cash flow. Many businesses, especially new start-ups, encounter struggles with either cash flow or profit at some point. However, if either cash flow or profit remains insufficient, eventually, your business will be unable to continue operating.
If you are struggling with your cash position and would like to discuss possible solutions to improve your situation, please do not hesitate to contact your client manager directly, or via the enquiry form on our website.
If you would like to know more about the Accountancy Services we offer, then the easiest way to do it is to go to our website and take it from there!
If you’re still unsure about us, you can see our full testimonial page at testimonials
Interested in contacting us in regard to this post or have another question you would like us to answer? You can phone or email our office. More information on contacting us at contacts