Let us today revisit the issue of cash in the business. Of course cash is a very important factor in business and also in personal and family life. If you don’t agree with me here then possibly you might be from another planet and not earth. I’m currently speaking from the perspective of the earth only. It is usually said that cash speaks the language that everybody understands. I have previously posted some articles on cash in this blog, and you might give yourself a gift by reading those articles. These include Why An Entrepreneur Must Understand His or Her Cash Flow, and Part 2 of that same article, together with Why Cash Flow Problems May Persist In An Enterprise.
Sometimes an entrepreneur might not decode why he has made so much profit in a given period and yet there is no money in the bank to reflect this. To entrepreneurs who can interpret financial statements this might be a no-brainer, but unfortunately not all entrepreneurs fully understand and can analyze financial statements. Now, it is neither a sin nor a crime for an entrepreneur not to understand every detail of a financial statement, though this leaves some gaps in decision making for the enterprise. Many enterprises have accountants (bean counters) anyway, so an entrepreneur who cannot fully understand financial information can simply consult his accountant. Let’s assume the accountant is able. Are we together so far?
So, in my blog today I intend to briefly explain why profit does not equate to cash. I mean, why an enterprise might make so much profit but close the year with hardly any cash in the coffers. These are also the reasons why a company might make huge losses and still have cash in its coffers after all. We are talking about reasons why accounting profit does not equate to cash and cash equivalents in the business (whether in the premise or in the bank). I know some entrepreneurs don’t like keeping their monies in the bank, for whatever reasons. They like to see money near them in the house or in the business premise! I will spare you for today if you are such an entrepreneur, but you might not escape my rebukes next time! Ok?
This topic is not a difficult one, and under normal circumstances every entrepreneur should understand this. Don’t you agree with me? By the way, in most financial statements, there is a page or section called statement of cash flow or cash flow statement that provides this reconciliation. It starts with your book profit and ends with your cash and cash equivalents at the close of the period. The problem is that many people do not bother to study this section of the report. Additionally, some accountants simply cannot explain this fact, leave aside doing the reconciliation. Now, when the tzars of numbers fail then you can only imagine what happens to the rest. Can’t you? I insist – it’s not a difficult one and in this write up I will try and keep it simple for everybody to understand. Let’s go now.
So, my dear entrepreneur, I believe you now have some good clues as to why sometimes your cash balance is very far away from your reported profit as per your financial statements or books of accounts. You don’t need to be worried and clueless – always relying on your accountant who might even give you wrong information and explanations regarding some business situations. Having someone who has an accountant’s qualifications is very different from having an accountant. Do you get what I mean? Not every accountant is worth the name, so sometimes you have to find your own way of understanding your business to avoid being taken for a ride. The above factors explain the variance between net profit and cash balances hence should put your mind to rest because sometimes the two are very far apart like Tokyo is to New York.
The above factors also explain why you can be making serious losses but your cash balances are positive and you are staying afloat. Without these reconciling items, one would assume that your losses should translate into bank overdrafts or loans etc. Situations where net profit equals to cash balances are very rare and unique. An example is where you purely use cash accounting instead of accrual accounting. In this case you can mechanically trace every kobo or coin into your profit and loss account and subsequently into your cash and bank balances. Your cash balances, among other factors, by the way determine your ability to settle bills as they fall due. Mess with your cash flow management at your own risk! Ok? At least my hands are clean, because I’m giving you valuable and free advice.
I guess I need to end it here for today.
With every good wish – and till then,
The Wise Entrepreneur