| Profit Does Not Equal Cash in the Bank

Posted in Business Finance Lessons at 9:00 AM by Loftis Consulting

Many entrepreneurs consider profits reflected on their Income Statement as cash in the bank from running their business.  This is not the case for many reasons.

Reason 1: Cash can come from non-operational sources

If your business is lucky enough to get cash from outsiders, this cash is not considered profits.  It is cash (i.e. funding) from investors in the form of bank loans or equity stakes.  This type of external funding will not show up on the Income Statement, where we determine if the business has accounting profits.  Accounting profits means the business has profits by accounting for all the revenue and expenses that were incurred for the measurement period (e.g. one month) regardless if the revenue was collected or the expenses paid.  In other words, there can be accounting profits with zero or negative cash flow.

Reason 2: Not all revenue is equal

For most businesses, when a product or service is sold, the customer can pay using cash or credit.

  • If it is a cash sale, the business has cash flow immediately
  • If it is a sale on credit, the business has credit revenue; however, the customer doesn’t have to fork over any cash until the agreed upon due date. Let’s use an example of 30 days.  On the day of the sale there is credit revenue recorded on the books; however, no cash comes in the door until 30 days later.  The credit revenue is not converted to cash revenue until the customer pays.

If your business provides sales on credit, just because there is revenue it does not mean that you have that much cash in the bank due to payment terms as well as the fact that some customers may default.  In other words, the Income Statement Revenue shows customers’ promises to pay for products received for services provided by your company.

Even though profit is not the same as positive cash flow as explained above, profit is still important.  Business profits show how well the owners of the business are using the resources it has to make sales at a price or rate high enough to cover all expenses, long-term investments such as equipment and provide a return to the owners of the business.

Now that you understand why profit and cash flow are not the same, it is important to understand the ins and outs of cash flow. To get started on understanding cash flow check out “How to Keep Your Business Cash Flow Healthy with Financial Checkups”.

ABOUT US:

Loftis Consulting is an outsourced CFO service provider.  In addition to CFO services, Loftis Consulting offers one-on-one professional financial coaching for individuals looking to improve their financial intelligence to advance their business or career.

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