What’s the difference between profit and cash?

 In Small Businesses & Startups

When starting out in business, profit seems to be a relatively simple value to calculate:

Income minus Expenses = Profit

However this is actually a gross oversimplification that may have significant consequences for your business.

If your business operates accounts on an accruals basis, your business shows a profit from the moment that the invoice is issued to a customer. But until payment is received, that profit remains an intangible sum, money that cannot be invested or spent. Your accounts show a profit, but your bank balance tells a different story because you cannot spend profit, only cash.

Without cash, your business is unable to meet its own running costs, or pay suppliers. So if your customer is late paying their bills, your cash deposits could begin to run low. If too many customers delay payment for too long, your business could cease trading, even though you are showing a profit on paper.

A healthy cash balance is essential for keeping your business functioning, particularly as cash flow can fluctuate dramatically. You will also find that applications for funding or loans are often made on observations of your cashflow, rather than profit, further emphasising the importance of getting bills paid rather than simply entered onto your accounts system.

As always, the best strategy is to seek professional advice from an experienced small business accountant who can provide guidance as to how to increase cash reserves in line with profit. They will also be better able to help you calculate profit correctly so that you pay the correct amount of tax and claim any reliefs to which you are entitled.

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