What is the difference between profit and cash?
Why do we see profitable businesses run out of cash?
Find out more about this mindset below with Jason!
Profit is your total sales value, less the cost of the stock and other expenses in your business that doesn’t include your drawings. It doesn’t include your debt repayments. It doesn’t include any dividends or repayments to your owners. Profit is only the sales value, less the cost of all the stuff that you’ve used that you’ve had to incur in order to make that sale.
Cash is all cash inflows, less anything going out. It’s also going to include GST. Key consideration there is that profit doesn’t include GST, whereas cash does. So, cash is just the dollars that are coming into your bank and the dollars that are going out.
Even just from that explanation alone, you can see there’s a really big difference between the two of them in real simple terms. You’ll see that for instance:
- GST is not involved in profit at all, but it is clearly cash.
- Loan repayments, are certainly not profit however, they can have a serious impact on your cash but interest on loans will reduce your profit because interest is a business expense.
- Cash spent on assets (like a new car) isn’t going to reduce your profit, but it’s sure as heck going to reduce your cash balance.
- Cash received from the sale of assets, in many cases, is not profit but it does increase your cash balance. Conversely, depreciation will reduce your profit but that’s a non-cash adjustment.
The one main thing to understand in all of this is the impact that things like the examples above have on profit and ultimately tax.
Tax doesn’t reduce your profit, but it will reduce your cash.
So, if you’re a business that’s fully funded by debt and you’ve got sales coming in and not many expenses going out, you’re going to have a lot of profit. However, that’s going to then mean generally, you’re going to have to pay quite a bit of pay tax.
But what if all your money’s gone out to pay loans and interest? You’re going to have no cash left over to pay tax.
This is where a lot of businesses are getting into this horrible downward spiral when we are showing high profits on our P and L but the business is hemorrhaging cash and we’re unable to meet our tax requirements.
Understanding the difference between profit and cash is the first step we need to take when discovering the health and well-being of our business. If you are unsure about how your profit and your cash work and the impacts that all of that can have on your business, please get in touch with us at SMYD Accounting / Advisory. We can help you understand the profit/cash relationship and set you on a path to solving your cashflow issues.
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