Every Business owner needs to know - The difference between profit and cash

If I had collected “2 bob” from every good customer who has posed the question; “where has my profit gone?” …well, I’d have quite a few extra dollars.

I’d often sit with these mostly fledging business owners and run through their trading results. When we’d get to the net profit outcome, “THAT” question would be posed.

The answers, when explained, are quite logical, and easy to understand. However, the real learning of the conversation is what actions we will take to better understand this profit v cash equation., and then plan for the business’ cash needs.

The reasons for this vacuum of cash, despite the “paper profit” is ALWAYS one of a combination of the following reasons:

• Profit is tied up in either growth in stock, accounts receivable or works-in-progress,
• Profit has been used to pay down trade creditors,
• Profit has been used to pay income taxes (for either the current or prior periods),
• Profit has been used to pay down debts,
• Profit has been used to purchase business assets,
• Profit has been extracted by business owners as “drawings/loans” to fund personal expenses.

To identify and quantify the reasons for this “cashless profit” position we often use a ‘source and application of funds’ report that clearly sets out where the cash has been sourced and how it has been applied. This report is great to analyse what has happened. HOWEVER, a far more valuable financial tool, and to action the “learnings” that I referred to above, is the preparation of a cashflow forecast or budget.

Revenues are forecast, business expenses of stock purchases, labour, overheads, finance cost, etc. are estimated and documented. Then, the balance sheet movements need to be forecast. That is, those matters of debtors, stock growth, tax and debt payments and importantly owner’s profits (their deserved returns for their business risk) are forecast.

This all sounds like a plan! And it is great to have a plan.

The last crucial component of their fiscally responsible strategy of our fledging business owner is to monitor the financial plan against actual results.

This planning and monitoring strategy provides crucial data and understanding to make better informed strategic decisions to enhance your business.

So, to summarise;

Step 1: Understand the difference between profit and cash
Step 2: Analyse the source of funds and use of funds
Step 3: Plan or forecast your trading operations and cash needs
Step 4: Analyse your actual results against your forecasts and recalibrate.

For further information about 'The difference between profit and cash', or if you wish to discuss this within your business, please contact our office and speak with your Client Manager or Jayde. Call us today on 4925 1000!

Written by Director, Chris Sneddon

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