Reviewing your business finances and Knowing your numbers is crucial for running a successful business. Has your accountant ever presented you with a statement of your profits that did not match the amount in your bank account? Are you curious as to why that is the case? Let's find out some common reasons for having differences in profit and bank balance.
What is profit?
Profit is the money you have left after paying for all your business expenses. To calculate your profit, subtract your business expenses from your total revenue. You are indicating whether or not your business can continue working.
What is cash flow
Cash flow on the other hand has nothing to do with sales. Instead, it determines whether or not you can support yourself and your team. Subtract the cash outflow from the cash inflow to get the figure. When your cash flow is negative, your outgoings exceed your incoming.
Common reasons for having differences in profits and bank balance
Prepaid expenses are assets on the balance sheet that arise when a company pays in advance for products or services that will be received at a later time. While the value of any prepayments made for future costs is initially recorded as an asset on the balance sheet, it is gradually written off against operating income. Rent and insurance premiums are a couple of predictable costs that can be paid in advance.
Imagine that your insurance company gives you a discount for paying your premium in full for the entire year. While the amount will affect the cash flow of your business, when reviewing your profits & loss statement you will only see the impact of one month of expense. Thus resulting in the differences between your profit and your bank balance.
The term "repayment" refers to returning borrowed funds to a lender. Payments are made regularly and always include the original loan amount plus interest. What was initially borrowed is known as the loan's principal. Borrowers are required to pay interest in exchange for the usage of the money that was made available to them through the loan.
Assuming at the certain time of owning your business you took a loan, and now you have to make a monthly payment to repay that said loan. Let’s assume the monthly payment for the loan is $1750. Of that amount, $1000 represents the principal, and $750 is the interest payment. While the full payment of $1750 will affect your cash flow, the only amount that will impact your business profits & loss statement is the $750 related to interest because that is the true expense for the month.
A company makes a capital investment when it buys tangible assets to achieve its long-term goals and objectives. Among the assets that are purchased as capital investments are real estate, factories, and equipment. The IRS requires accountants to move purchases of assets above a certain threshold or expected life from an expense to an asset. An asset goes directly to your balance sheet and is only deducted from your income when it is depreciated.
As part of growing your business, you decided to hire a new employee. You had to provide a new computer and a workstation for the new employee. The cost of adding new furniture and equipment is considered as fixed asset in your balance sheet. While the full cost of those purchases will affect your cash flow in the month you made the purchase, when reviewing your profits & loss you will only see the portion of that cost that is related to asset depreciation.
Owner contribution and draw
Lastly, one of the most common reasons why your profit & loss statement will not match your bank balance is because of the owner's contribution and draw. As a sole proprietor, you might never have any of the scenarios above. However, as a business owner, you will always be putting money into the business and also taking money out of the business. What you put in is considered your contribution and what you take out is considered your draw. While these activities will affect your cash flow, they will not reflect in your profit and loss statement. Those transactions would be posted on your balance sheet as part of your owner’s equity.
How to Fix the Net Profit & Bank Balance Difference?
The sum of your cash on hand and your net profit will never be the same. So, the truth is, you shouldn't aim for a profit equal to your bank balance. The business's health has been measured by its ability to increase shareholder value.
Talking with your accountant at least once a year to discover why your profit differs from your bank balance may help uncover places where cash is being tied down and lead to quick wins to boost your cash flow. You may get the most transparent and accurate picture of your company's cash flow status by carefully analyzing the changes in your balance sheets. Money can "disappear" in several locations, including insurance policies, structures, and merchandise.
For personalized bookkeeping services that take the headache out of numbers, feel free to schedule a consultation call to learn more about how we can help you grow and manage all your accounting needs.
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