subject: Do You Understand The Difference Between Your Profit And Loss Statement And Bank Account? [print this page] Small business owners can find areas of accounts confusing and do not understand what is actually happening in their accounts.
Product based industry
The biggest challenge that product based industries face is the actual product they sell stock. The key element to understanding the difference between your profit and your cash flow lies in a number of variables:
* How long are you holding your stock
* How long it takes for you to pay your suppliers for that stock
* How long it takes you to get paid by your customers for that stock
Your Profit and Loss Statement shows purchases and sales. It records the sales transaction, but it does not record how long you are holding the stock item, how long it takes you to sell that specific item or how long it takes your customers to pay you. That is all shown through your bank account. Your bank account is your cash flow and this reflects the real transaction. These variables have the biggest impact in terms of the differences you will experience.
Service based industry
For service based industries the theory is essentially the same, as the challenge lies with your stock, that is your time. The variables you need to consider are:
* How long you are keeping work that you do for clients in a work in progress state
* How long does it take you to charge out your time
* How long does it take you to pay your suppliers (i.e. contractors/staff)
* How long does it take for your customers to pay you
General considerations
Identifying payments that go through your bank account that are not captured on your Profit and Loss Statement impacts all industries. Often small businesses don't understand what these are. When working out differences, be sure to include the off P&L items such as:
* Loan repayments
* GST payments
* PAYG payments
* Other Tax Office payments
* Hire-Purchase payments
* Business owner drawings (if you are not paying yourself a salary/wage through your payroll)
These items are not allocated to your Profit and Loss Statement/Report, so if you draw from your P&L and deduct these items you should be able to get a reality check in terms of what is truly happening in your business. To get the real picture you need to look at all these factors, not just your P&L in isolation.
