Hi there fellow business owners,
In the world of business finance, understanding the distinction between profit and cash is crucial for making informed financial decisions and ensuring the long-term success of your venture. It’s not uncommon for business owners to feel frustrated when their bank account doesn’t seem to reflect their profits.
This blog aims to shed light on the difference between profit and cash by introducing the Business 101 Cycle, a valuable framework that illustrates the interplay between these two essential financial aspects.
The Business 101 Cycle is another useful way to demonstrate the difference between profit and cash.
First, the owners need to invest money in the business.
This money can then be used to purchase the assets needed to run the business.
The business may need additional funding to buy all the assets they need, so they may take a loan to finance the purchases.
These assets are then used to generate a profit.
You can increase your profit by growing your sales or margins, but overhead expenses can drain your profit and result in a loss if they’re not managed.
The profit then gets turned into cash.
Drains on your cash include slow collection of debtors, high inventory days, loan repayments, tax repayments and payments to suppliers.
A business can achieve cash gains by collecting their debtors faster, decreasing their inventory days, negotiating longer payment terms with suppliers, and reducing tax.
The owners then take cash out of the business as drawings or personal loan repayments. The remaining cash can then be re-invested into the business to purchase more assets to generate more income.
The aim is to go through the cycle as quickly as possible to increase your return on investment.
Importance of Understanding Profit and Cash
Business owners often face the challenge of their bank accounts not accurately reflecting their profits. This disconnect between profit and cash highlights the significance of comprehending their differences. A high profit doesn’t necessarily equate to ample cash in the bank. A profitable business can still struggle if it lacks sufficient cash flow, while a business running at a loss may survive through external funding sources.
Key Considerations: To further emphasize the difference between profit and cash, consider the following items:
- GST affects cash balance but not profit.
- Loan repayments impact cash balance but not profit.
- Interest on loans affects both profit and cash balance.
- Asset purchases solely influence the cash balance.
- Asset sales also only affect the cash balance.
- Depreciation, on the other hand, solely impacts profit.
Watch this video here where I talk about this in detail.
Mick
I’d love to help you achieve your business dreams, please don’t hesitate to contact me;
07 5646 4050
mick@ignitionaccountants.com
Book a call for a complimentary Proactive Accounting Meeting to discuss your accounting profitability
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