One of the questions I often get from our clients is why they are making profit & yet they have no money in the bank. So, let’s look at these two reports to understand why.
Cash flow statements and profit and loss statements are two kinds of financial statements that a business owner uses to measure their business' financial health.
The main difference between a profit and loss statement and a cash flow statement is that a profit and loss statement measures the profitability of the business while a cash flow statement shows where your money is coming from, where it's going, and how much cash you actually have on hand at a given point in time.
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Understanding your cash flow statement vs profit and loss statement is essential for ensuring a viable, financially healthy business.
Profit and Loss Statement
In many ways, the profit and loss statement is the simplest kind of financial statement to prepare and understand in small business bookkeeping. This kind of income statement records revenue and expenses for each month to see whether the business is making or losing money. This, in turn, will help you work out whether you need to increase your profit margins or lower your expenses to ensure that your business is sustainable.
Cash Flow Statement
Whereas a profit and loss statement tells you whether you're making money, a cash flow statement tells you whether you can pay your bills. As a measure of liquidity, a cash flow statement tracks cash inflows and cash outflows on a day-to-day basis and tells you your cash balance at any point in time.
A negative cash flow may indicate that a company is growing, i.e the business made some investments or some asset purchases. However, if the profit and loss statement shows a loss, a negative cash flow could mean that the company's business model is unsustainable and significant changes need to be made.
If the cash flow statement shows positive cash flow and the P&L statement shows a profit, that usually means that the business is well established. However, for a startup, having a positive cash flow and an overall loss often indicates that the business took out a loan or that the business owner drew on their personal account to keep the business afloat because the actual revenue received wasn't enough to cover their costs.
When to Get Professional Help
Many startups begin by keeping track of their accounts receivable, accounts payable, and cash flow using spreadsheets in Excel. In this case, you would need separate spreadsheets for your cash flow statement vs. profit and loss. However, as your business grows, you might find it more practical to get an accounting system, or to consider outsourced bookkeeping. Whether you decide to do your own bookkeeping or have someone else do your bookkeeping, it's important to see a small business accountant on a regular basis to analyze your financial statements. The accountant will be able to explain the different accounting methods, identify places where you could improve your income and reduce your expenses, and help you with strategic tax planning. Rhina Namsia Bsc., FMVA®., Kyesubire Greigg
