Myth #3 – Cash is profit. Profit is cash. FALSE!
Too many business owners use their bank accounts as the only measure of how well their business is going. What you have in your bank account today, by itself, is no indication that your business is going well or not. It is only one guide of how well your business is going.
It’s easy for us to see if you don’t understand the difference between cash and profit. You typically ask the question (whether that’s to your accountant or yourself) “If I made $50,000 profit, why don’t I have that in my bank account?”
There is a saying “sales is vanity, profit is sanity, cash is reality”. What this means is twofold:
- There is a relationship between sales, profit and cash – but they are all not the same thing! Sales (less costs) gives you profit. And profit (after adjustments for increases/decreases in debtors, inventory, creditors, investments, loans, fixed assets) gives you cash.
- You need to pay your bills using cash. It doesn’t matter if you have $2m in sales if you have nothing in your bank account to pay your bills. You may get an ego boost telling people you have a $2m business, but that means nothing if can’t pay your bills. That’s why “cash is reality” or more commonly you may have heard “cash is king”.
The profit you make is an indicator of your business performance taking into account all income and costs for a specific time period, regardless of whether the income or expenses have been received or paid in that time period.
Cash is the result of what you bank and what you pay up to and including today. It does not reflect things like:
- Customers who owe you money
- Suppliers you owe money
- What you owe the tax man
- Things you’ve bought that you use to help you generate income (referred to as fixed assets)
- Investments in shares or intellectual property (trademarks, goodwill …)
- Loan repayments (or drawdowns).
You should use both your profit and loss, and cash flow reports to measure how well your business is going. And because your business and your goals will be unique to you, you need to know which measures of cash and profit are most important to you.