So why don’t the numbers add up?
We get asked this question on numerous occasions, “If I made a Net Profit of £25k, why do I not have £25k in the bank?”
Making a Profit is always a good thing, however, making a loss is not so good. This is where the confusion begins! Why is there a Profit, but no money in the company bank account?
To put it simply profit does not equal money in the bank.
Profit has no connection to how much money is in the bank. To better explain this let’s look at your business profit and loss report. A P&L will provide details of the total income generated from your business activities, less any cost of sales to give you your gross profit from trading activities. It will also list your operating expenses such as stationery, telephone costs, rent, payroll etc which makes up your total expenses.
If you take the gross profit from the total expenses this will show you your net profit or loss from trading activities. In a nutshell, this is what is often referred to as monies in and money out of the business.
To explain this further, let’s look at an example based on a cash business;
Your business produces an invoice for of £5000, this is recorded in the business accounts and is shown as income in the profit and loss account. No expenses have been created yet, therefore, the P&L shows a net profit of £5k. No payment has been received from this invoice and no money has been paid into the business bank account.
Out of that £5k income, you now pay operating expenses such as rent motor costs etc. Your P&L shows that your operating expense has increased and depletes your bank account when the payment is recorded by the bank in the company accounts on the Balance Sheet. Your P&L is showing both types of transactions (money in and money out), however, your actual bank account doesn’t! This is because you have not received the payment from your customer so your actual bank account does not reflect the £5000 deposit.
Your P&L only shows your trading income and expenses, it does not show any liabilities such as business loans, taxes, etc, nor any purchase of assets as these are shown in the Balance Sheet and also paid via the bank account.