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If There is Profit, Where is The Cash?

Have you ever reviewed your Income Statement at the end of the month and breathed a sigh of relief?

The bottom line is excellent. 🎉🎉🎉 Another profitable month!

Your mind wanders to how you’ll celebrate as you scan the Balance Sheet to see that beautiful bank balance.

Wait. Your Net Income and your bank balance are drastically different. WHAT???

Who the heck is stealing from you????

Well. I can’t say for sure, but there is a good chance theft is not the problem.

So the question is “if you have a profit, where’s the cash?”

And we get asked this all the time!

Unfortunately, the answer lies in the most complicated of the financial statements. I was going to say in my opinion, but I can’t imagine anyone would disagree!

It’s the dreaded Cash Flow Statement.

Don’t worry though, we’re going to break it down! And by the end, I’m guaranteeing an ah-ha moment or you get your money back! 😊

Now if you’re using accrual basis accounting, the disparity between your profit and cash will be more drastic than it would if you use the cash basis of accounting.

Accrual basis means you record revenue when it is earned (even if you haven’t been paid) and you record expenses when they are used (even if you paid a long time ago or haven’t paid yet).

This is why revenue and expenses alone are not going to tell you how much cash you have available.

That might make cash basis accounting sound appealing, but the matching principle of accounting says accrual basis is best practice (for good reason, but let’s save that for another day).

Back to the Cash Flow Statement!

Understanding the Concept


The truth is, you don’t need to understand every line on the Cash Flow Statement to answer your question. You do need to understand a few key concepts.

Once you get the gist though, you’ll be able to think through every line!

1. Profit is the bottom line of the Income Statement (revenue less expenses).

2. BUT cash is also coming in and being spent on items that are NOT on the Income Statement (like PP&E).

3. AND revenue and expenses are being included in your profit that you didn’t receive or spend money on (like depreciation).

4. Those items are on the Balance Sheet.

5. The Cash Flow Statement reconciles the two.

The Nuts and Bolts


The Cash Flow starts with the beginning balances of your cash accounts for the period. Then adds your Net Income (what you are expecting to add in cash). Then adjusts it for each line of the Balance Sheet (based on how they affect your cash).

Beginning Cash + Net Income + (-) Balance Sheet adjustments = Ending Cash

The adjustments are broken down between Operating, Investing, and Financing activities but those categories are not really crucial to understanding how the Cash Flow Statement works. They are just a way of organizing the data.

At the end of the Cash Flow Statement you should be able to see that the formula above matches your cash balance at the end of the period.



Some Examples


If that still just sounds like a bunch of random words strung together, that’s OK! Just go with me for a minute.

I’m going to come in clutch with 3 real-life examples 😄😄😄


1. Over the period your payables may have decreased (money you owe to vendors). An overall decrease means you spent cash paying old balances that were not included in your Net Income. That would be subtracted from your cash balance. The image below shows how this would be listed on your Cash Flow Statement.



2. A decrease in your receivables for the period would have the opposite effect. If your overall accounts receivable balance goes down, that means that people have paid you what they owe. It would have been recorded as revenue in a prior period. So you would add that back to your cash balance, as shown below.



3. And Amortization and Depreciation can always be added back to your cash balance! It is an expense that reduces your Net Income, but it doesn’t actually affect your cash.



Said another way

Let me say it again, another way.

We start with our Net Income (our profit) and then we make adjustments because we realize things like:


-Bummer, my profit included XX of revenue but I didn’t receive cash for that (an increase in accounts receivable).

OR

-Yay, accruals reduced my profit by XX, but I didn’t have to pay anything (an increase in accruals)!

After making all the adjustments to Net Income, the Cash Flow Statement comes down to an adjusted cash balance.

This number should match the ending bank balance on the Balance Sheet. That tells you everything was accounted for and adjusted properly!

Now the good thing is: you or your accountant builds a Cash Flow Statement once and you don’t HAVE to think through every line every time you run it. You just look at the bottom line of the Cash Flow Statement and see that it reconciles to the ending bank balance on your Balance Sheet.

But now you CAN think through every line of the Cash Flow if you want to!

The bottom line about the bottom line


And if you absolutely are not interested in all that mumbo jumbo above, and you were wanting a MUCH shorter answer to the question: “Why doesn’t my profit match my bank balance?” here you go:

It’s a timing difference. 😊


Stay tuned for an article on why your bank balance on your Balance Sheet doesn’t match your bank balance when you log into the bank! Again, no one is stealing from you! Probably.