Cash Is King!
What is the Difference Between Cash Flow & Profit you ask? Cash flow and profit together are what keeps a business thriving. You can't be so busy leading your business that you forget to manage by the numbers. At the end of the day, it is the numbers that make or break your business. You should understand how cash flow and profit impact your business.
The quick and simple explanation of cash flow and profit are as follows:
Profit is the net of what is left on your Profit & Loss Statement when you subtract out your cost of goods sold and overhead expenses from your revenue.
Cash Flow is what brings money in and out of a business. This will include the activities on your Profit & Loss Statement (ie Revenues, Cost of Goods Sold and Expenses); however, there are two main areas that impact cash flow that you will not find on your Profit & Loss Statement (ie P&L Statement).
What are they?
1. Loan Proceeds and Payments. When you borrow money from yourself or anyone else, those loan proceeds simply increase your liability on your Balance Sheet. It is not income so therefore it doesn't show on your Profit & Loss Statement. When you go to pay back your loan, the only part of the payment that is an expense is the interest portion. The loan principle is not an expense; it is a reduction of your loan liability.
2. Owner Investments and Draws. When you contribute money to the business as an investment, it is not income; it is an increase in Equity on your Balance Sheet. When you take monies out for personal use, it is not an expense (unless you run it through payroll expense and withhold taxes), it is a reduction of your equity (aka draw).
This difference between cash flow and profit is what can get some businesses in a bind. For example, if a business only has $1000 profit, but their loan principle payment is $1500, they would be profitable but have a negative cash flow.
It is imperative to be savvy when handling your business finances and to clearly understand how the dollars coming and going from your business are classified as money is the life blood of all businesses. I can't tell you how many business owners don't even look at their financials and then at year end they panic when you discuss taxes. They key is understanding that good bookkeeping is for your benefit first, not just the bankers or the tax person. You need to know what is happening. You don't have to be everything to your business, if you aren't sure how to analyze your business by the numbers, no problem. There are various resources that can help you better understand them, you just have to make it a priority.
About the Author
About the author: Pam Newman Morin, MBA, is a Certified Management Accountant, Author, and Advanced Certified QuickBooks® ProAdvisor. She is the President of RPPC, Inc, which is an Accounting Firm that specializes in QuickBooks® services. For more information: Website is http://rppc.net/ Twitter @RPPCInc, Follow us on FaceBook at QuickBooksPam, YouTube Channel is RPPCInc, or call 888.536.9690
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