Where’s my money?

Your Income Statement has a lovely healthy profit but your bank balance is moth-eaten and sad, how can

“But if that’s my profit, why is my bank account so empty?”

This is a question I encounter on a regular basis when a business owner looks at their Income Statement – especially at tax time! Your Income Statement has a lovely healthy profit but your bank balance is moth-eaten and sad, how can both be accurate?

So, why does the profit on your Income Statement never match the balance in your bank? Here are the two very simplified reasons:

  1. Financial Reports are done on the Accrual Basis not the Cash Basis

This very simply means that your accounting documents are all recorded according to the date of the transaction – not the date of the payment. So, your income is recorded when you send an invoice, not when the client pays you. Your purchases are recorded according to the date on your bills, not on the date you pay them.

This means that your income statement will reflect income that you have not yet physically received, which is one of the main reasons for the discrepancy between your profit and your bank account.

This becomes a big problem if you don’t have a good collections process – you will need to pay taxes on your big sales regardless of whether or not your customers have paid you!

2. Not all your cash outflow shows on the Income Statement

The Income Statement only reflects two categories of business transactions: income and expenses. You have three others: Assets, Liabilities and Equity –  these three are reflected on the Balance Sheet instead.

In other words, if you buy a new computer or you repay a loan or you pay yourself a dividend, those cash payments do not affect your profit. Any money flowing to an asset, liability or equity account will have no affect on your Income Statement, but they do still very much affect your bank balance.

These are the two main reasons why you can reflect a profit but have no money in your bank account. They are also the two main reasons why cashflow planning and management is so vital for a business. If you don’t know:

  • Who owes you money and how much
  • Who you owe money to and how much
  • What debts are due for payment soon
  • What savings you have on hand

Then you will not be able to plan properly for taxes, bonuses and the unexpected. There is a saying that “failing to plan is planning to fail” and this cannot be more true than when applied to cash management. If you do nothing else for your business in 2020, implement a cash management system – you will be amazed at the difference it makes!

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