Where Are My Profits

It can be perplexing for business owners to see strong net profits on their profit and loss statement only to find that their bank account balance doesn’t reflect this success. This disparity often stems from the difference between profitability and cash flow. There can be multiple reasons, but here are some of the most common.

1. Owner’s Draws or Dividends
If owners are taking money out of the business for personal use, this doesn’t appear as an expense on the profit and loss statement. Instead, it is recorded as an equity transaction. These withdrawals directly impact the bank balance but don’t affect the net profit calculations.

2. Loan Payments
Loan payments include both principal and interest. While the interest portion appears on the profit and loss statement as an expense, the principal repayment does not. However, both reduce the bank account balance, contributing to the gap between profitability and available cash.

3. Significant Investments in Assets
Large purchases, such as equipment, vehicles, or technology, don’t show up as immediate expenses on the profit and loss statement. Instead, these investments are recorded as assets and depreciated over time. While they don’t reduce the net profit immediately, they do impact the cash balance at the time of purchase.

4. Unreconciled Transactions
If bank and credit card accounts have not yet been reconciled, there can be duplicate or missing transactions that need attention. These erroneous transactions in the books impact the accuracy of net profits shown on financial reports.

5. Inventory Purchases
For businesses that sell products, inventory purchases can significantly impact cash flow. Buying inventory is recorded as an asset until the products are sold. This means that while cash is spent upfront, the expense is only recognized when the inventory is sold, creating a mismatch between profit and cash.

6. Timing Differences Between Income and Expenses for Accrual Based Accounting
For businesses running their financial statements on an accrual basis, net profit is calculated using revenue earned and expenses incurred during a specific period, regardless of when cash is actually received or paid. For example:

Accounts Receivable: If a business invoiced customers but hasn’t received payment, those sales contribute to the net profit but don’t add to the cash balance yet.
Accounts Payable: If the business incurred expenses but hasn’t paid them, your cash flow is temporarily higher than it would be after making those payments.

Managing the Discrepancy

To better align profitability with cash position:

Monitor Statement of Cash Flow:
Use a statement of cash flow to track how money moves in and out of the business. This provides a clearer picture of financial health.
Improve Receivables Collection:
Implement strategies to encourage timely payments from customers.
Manage Payables Strategically:
Take advantage of payment terms to retain cash longer without incurring penalties.
Plan for Taxes and Large Expenses:
Set aside funds for taxes and other predictable expenses to avoid sudden cash shortages.
Review Inventory Practices:
Optimize inventory levels to avoid tying up too much cash in unsold goods.

Conclusion
High net profits are a great indicator of business success, but they don’t tell the whole story. Understanding the difference between profitability and cash flow is crucial for maintaining financial stability. By staying proactive and informed, the business bank account remains as healthy as the profit and loss statement suggests.

If you would enjoy a guided tour of your financial statement with an expert, contact Morgan Morrow Bookkeeping.

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