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Profit or Cash – what’s the difference and why does it matter?

12th March 2018

 

 

What on earth is your accountant talking about?! Business is booming, you are making a fine profit – so why is there no money in the bank? Where did all the money go?

This is a common question from small business owners as they try to understand their numbers and the difference between profits and cash is essential to ensure you are managing your business correctly. 

Understanding profit

In accountancy terms, the Profit and Loss (P&L) account shows a very simple calculation:

P&L Account

A sale, according to the P&L is when you raise an invoice, so in other words the date at the top of your invoice.

A cost is recorded on the date the supplier raises the bill to you, so in other words the date at the top of the supplier invoice or receipt.

So, using a really simple example, lets say you raise an invoice for £1000 and you buy some advertising for £500. A £500 profit. Nice! 

Understanding cash

Cash, simply is money in the bank. The calculation is similar but subtly different.

Cashflow 

A reciept, as the name suggests, is when someone pays an invoice.

A payment is when you pay a bill.

In our same example, your customer pays you £1000, you pay £500 in costs. Cash in the bank £500.

So far, so good. So why does it matter?

The big ‘but’ which makes the difference

The big difference is a factor of time. When you raise an invoice (a sale) you give a customer time to pay – typically as much as 30 days. 

So, for those 30 days, you are showing a £500 profit, but there has been no corresponding receipt into your bank account. 

If you’d started with a zero bank account and are a responsible business owner who pays their supplier bills promptly, you’ve just run out of cash. 

The big difference

And that’s why the difference matters. 

And VAT makes it even more complicated

If you are VAT registered, there are three figures you have to consider on top of those listed above. 

1. Sales and Costs are registered on P&L with the VAT already deducted (net Sales and net Costs)

2. Receipts and Payments will include the VAT as they go in and out of your bank account

3. The payment of the VAT to HMRC is taken from your bank account 37 days after the end of each financial quarter as a single transaction. 

And of course, all of the above assumes that all your customers are organised and on the ball and pay their bills on time. Outstanding and overdue invoices add another little wrinkle to the numbers.

Is it any wonder that reconciling profits and cash is so complicated? And why it is so vital to be tracking your cash and anticipating when money is going out without assuming it will be coming in on time. 

 

If your numbers have you scratching your head, contact us for a free consultation on your P&L and Cashflow. 

 

 

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