Virtual CFO | Profit Versus Cash Flow
Business owners often have poor understanding of why they are making money in their business, but they are running out of cash says virtual CFO. Helping business owners understand come statements as well as profit and loss statements can help them understand how the money flows in their business, to help them avoid running out of money.
There are several questions that business owners can get the Institute in order to help understand how the cash flows in their business says virtual. The first question is, is revenue added to the income statement at the date of invoice or at the date of payment? The money shows up on the income statement as soon as the job is invoiced. So business owners need to understand that just because it shows up on the income statement, doesnít mean they received the money for it yet.
The next question is how can a sudden increase in revenue place strain on the cash flow? Virtual CFO says that this is often confusing to business owners because they believe that by having a sudden influx of revenue, they should be able to use that money immediately. However as revenue increases in the business, the expenses also tend to go up. And as the expenses increase right away, the business does not get paid until later, so this contributes to a cash crunch.
The third question is when you use cash to buy assets, is your profit and loss statement affected? The answer to this question says virtual is yes, business owner will see the money come out of their bank account right away, but it doesnít show up on the profit and loss statement the same way. So business owners need to be aware of that fact.
The fourth question is what happens to your cash balance when you pay off payables and credit cards? What usually happens in business is as soon as the money is collected, gets put towards the bills, so business owner will show as having no money in the bank account. Virtual says but the bills hit the income statement earlier when the is owner gets invoiced. So there happens to be a bit of a lag when the invoices are received and when the money is put towards the bill.
The last question is how do shareholder loans affect cash flow? A business owner needs to understand that the dividends never show up on the income statement. The owner has to take money out of business, but if they take more than the business is profiting, that contributes to a cash flow problem in the business. The business owner needs to be taking out as much as the business is profiting but not more. Virtual CFO says by looking at the income statements periodically can help a business owner know if they are taking more than they should out of their business.
If a business owner can understand the difference between profit and cash flow, they will be better able to make good financial decisions for their business.
50% of all businesses are out of business within five years, and 29% of those businesses will say that running out of cash was the reason their business failed said virtual CFO. Business owners can understand the finances in their business a bit better, they will be better prepared to make financial decisions in their business, and avoid running out of cash at crucial times.
By putting the answer to several important questions about finances, business owners can help understand the difference between profit and cash flow in their business. The first question is does the principal portion of loan repayments show up on the income statement? Virtual says this situation is often one that business owners misunderstand. What they need to know is only the interest shows up on the income statement. So if the business shows a profit of $1700, and a business needs to pay back a $1700 loan with a $300 interest payment, $300 will show up on the income statement, the $1700 loan will not, and a business owner will be left wondering why they donít have that $1700 in the bank. The reason is because it went towards the principal payment. If business owners can understand that the principal portion of the loan does not show up on the income statement, they will be better prepared to have the right amount of money in their bank account and understand what they might not.
why should profits be at least as high as shareholder draws and loan payments? The reason for that is quite simple says virtual CFO, the business needs to make an profit at least what the business owner is paying in loans and capital leases in order to not have a cash flow problem. If a business owner needs to pay back $3000 loans each month, they need to profit by $3000 in order to not run out of money.
The next question is why is it important to bill early and bill often? This is a great question, that can help business owners understand how they can help themselves increase cash flow within their own business the way they invoice says virtual. Since the invoices that the business owner since to their clients also have payment terms on them, the business owner weeks to bill that clients at the end of the month, and the client has 30 day terms, a business owner may be waiting for up to two months to get paid. However if they build earlier, for example on a weekly basis, and that client had 30 days to pay, instead of waiting two months to get paid, the business owner would be waiting significantly shorter amount of time. Virtual CFO recommends billing early and billing often, why build monthly when the business can bill weekly? By billing weekly, business owners can create a situation where they are getting cash flow into their business on a weekly basis, which can help alleviate cash flow problems.