Knowing how your business is performing is vital to making financial decisions and being empowered to explore new opportunities.
It’s not unusual for business owners to use their Profit and Loss account (P&L) and Balance Sheet to gauge business performance, however looking at actual cash movement rather than just your profit figures and balance sheet can tell a very different story.
The bookkeeping is up to date, the sales and profit figures look great but the bank balance doesn’t look good. This is because a profitable business doesn’t not automatically mean good cash flow.
Having an understanding of your actual cash movement and being able to spot cash gaps can help you manage your money and make plans.
Profit is your pre-tax earnings after expenses are taken into account
Your profit and loss report is a great tool for understanding how viable your business is, going forward. The report gives you the totals of all revenue within your accounting year versus the total amount spent to generate the revenue.
The profit figure on the bottom line of your P&L report represents pre-tax income remaining. As long as your profits are going up over time, you’re heading in the right direction.
Your profit & loss report could show a nice healthy profit, but your cash flow could still be taking a hit
Because your P&L accounts for all invoices generated (whether or not you’ve been paid) it could show a nice healthy profit. But if your clients aren’t paying on time, your cash flow is taking a hit. As a knock-on effect, paying your own bills could become more difficult.
The P&L also doesn’t take any liabilities such as tax into account. Your liabilities are found on the Balance Sheet. The Balance Sheet is a snapshot in time of a business’s assets, liabilities and Owner’s equity or capital.
The liabilities are what you owe to suppliers, lenders and HMRC, whereas the asset section records the value of assets such as positive bank balances, property, equipment and accounts receivable which is also known as debtors.
In other words, as well as what the business owns, the balance sheet will show you the total of what is currently owed to you and how much you owe to your suppliers, lenders and HMRC. This won’t show you when you’re due to pay these liabilities or when you expect to receive any cash owed to you.
I’m sure you’ve heard the phrase ‘Asset Rich, Cash poor’. This is what your balance sheet could be telling you.
Your balance sheet could show healthy ‘Total Assets’ but when we’re talking about cash flow, Accounts Receivable (what your customers owe you) is one of the most important areas you need to keep track of.
You need to have control of your cash movement – particularly what’s coming in and when. You don’t want your cash tied up in your customers’ bank accounts.
Getting paid on time is a crucial part of any business, at Fresh Financials we use Chaser to send automatic payment reminders to keep on top of payments coming in. When your customers pay on time, the Assets vs Cash in your business is in a much healthier position, meaning you’re able to make more informed decisions.
Cash flow is the movement of money in and out of your business
An integrated cash flow forecast will provide a much more accurate reflection of your cash position than a profit and loss report or balance sheet. This is because it takes unpaid invoices and bills into account, as well as accounting for liabilities such as VAT and corporation tax.
Once you can see a clear picture of what’s ahead you can avoid cash dips and take advantage of any extra money coming in.
If you are worried about being able to pay your suppliers or employees on time every month or want to know if you have the means to hire a new employee, a cash flow forecast will help. A cash flow forecast can help you:
- Know whether you can afford to hire new staff
- See what would happen if you lose a key client
- Be able to make informed decisions for the future
- Always know who owes money, how much, and when you need to get paid
- Track spending against what you have predicted
Getting started with a Cash Flow forecast and budgets
There are different ways to create a cashflow forecast, you can search online for templates and build a spreadsheet that works for you. You will need to manually enter data each time you want a new forecast. Or you can use a custom made cash flow programme such as Float which integrates with your bookkeeping programme.
The biggest difference between profit and cash is timing.
Cash flow forecasting can help identify which of your customers are not paying on time, customers who may be having a serious impact on your business’s cash flow.
Float and Chaser work brilliantly with the Fresh Financials team giving you vital up to date information so you know how your business is doing.
So there you have it, you know what a cash flow forecast can do for your business and that the biggest difference between profit and cash is timing! – it’s as simple as that!