Why is my cash balance different and not similar to my net profit? I had a nice profit last month but my bank balance doesn’t reflect this gain. Why is that?
Net income is the profit a company has earned for a period, while cash flow from operating activities measures, in part, the cash going in and out of your bank account during a company’s day-to-day operations.
One reason for the difference, net income does NOT include any debt you are paying down. Those loan payments are being reflected on your balance sheet, and are not reported entirely on the Net Income statement. Only the interest is. Therefore, your cash balance is decreasing, making your loan/ debt payments, but only a portion of the payment is expensed on the income statement.
For example, you are making a $1,500 monthly loan payment. $1,000 of it is applied to the loan and $500 is expensed to the net income statement. Your bank balance decreases by the full $1,500 amount, but your income statement is only decreased by $500.
For those that have a numerous loans and liabilities, this can definitely affect your cash flow and see little variance on your net income statement.
To have loans, means you are buying assets. Fixed assets are not expensed and therefore not reflected on the net income statement. While it is increasing your balance sheet or company net worth, it is decreasing your bank balance with no effect to your net income statement.
This is also true for owner’s draws/ distributions. Any money you are taking as owner distributions, is obviously decreasing your bank balance and not effecting your net income statement as an expense.
Another thing to consider and understand of a net income statement is that you can earn (invoice) revenue in one month but receive the actual cash in another month. Therefore, no funds hit your bank account in the month in which you earned (invoiced) it, but the revenue will be reflected on your income statement.
For example, let’s say you earned (invoiced) $100,000 in sales revenue and you incurred and spent $60,000 in expenses. That means your net profit is $40,000.
| $100,000 | Revenue Earned |
| <$60,000> | Expenses Incurred |
| = $40,000 | Net Profit |
However, out of the $100,000, only $70,000 was paid/ received. That means in that month, only $70,000 was deposited in your bank account. If you take the $70,000 received minus the $60,000 in expenses, your bank balance will be only $10,000.
| $70,000 | Revenues Received |
| <$60,000> | Expenses Incurred |
| = $10,000 | Bank Balance |
The key difference between cash flow and profit is while profit indicates the amount of money left over after all expenses have been paid, cash flow indicates the net flow of cash into and out of a business.
With the few examples provided above, it is important to understand the importance to NOT rely on bank balance accounting Profit and cash flow are just two of the dozens of financial terms and financials that you should have some understanding of to make informed business decisions. Review regularly, key accounting reports: balance sheet, income statement, and cash flow statement.
Your bank balance and net profit will never equal the same. Therefore, the goal is NOT to have your profit equal your bank balance. The goal for a company is to produce a net profit and have a positive operating cash flow.
With all this in mind, it is highly recommended to maintain your books and prepare financials on a regular monthly schedule.
Please contact Lean Ledgers if you need assistance in getting your accounting records cleaned up and maintained regularly. Let my company help get your accounting books concise, lean, efficient, accurate and necessary to were you can focus on collectively increasing your bank balance and generating a net profit!