I hear many clients say there is a profit in their business, then say they don’t have cash in the bank – what they often don’t realise is Profit does not mean Cash!
If you have all cash sales, profit will usually correlate closely with the bank account, depending on when banking is completed – that is you get paid immediately and bank it, and do not invoice (waiting to be paid in 7, 14, 30 days etc). And you pay your expenses with cash direct from the bank, the balance should be the cash Profit.
But if you invoice clients for goods and services, the timing of when customers pay has an effect on the cash the business actually has. For example not everyone pays on time, but if they did you would have more regular cash flow, and at the start the first money coming in would only be delayed by the terms at the beginning eg 7 days, 30 days. Once those days of waiting have passed, the regular payments will mean regular flow of money to cover your expenses.
What happens if clients are late paying? Then the debtors/accounts receivable asset account on your balance sheet will grow (that is where the invoice “waits” for payment) until the client pays.
As an example, in our earlier post explaining Profit and Loss, (see HERE we gave an example of Profit and Loss resulting in $15,000 profit.
Consider now, that you were only paid half of the sales at the end of the period (which is more close to reality – eg most pay the next month or two…in 60 days).
Sales (invoices) $100,000
But only paid (actual cash) $50,000
Which goes to bank (in assets)
Net Left $50,000
Which sits in debtors/receivables (in assets)
Note – PROFIT would be same in accounting terms, but CASH Profit would be -$35,000 – see below
That is – if you still had paid all your bills, you would have to find $35,000 to pay them!
This is where businesses will use credit cards or overdrafts to keep paying suppliers and the rent to stay open!
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