Cash flow is not Profitability

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Cash flow is not Profitability

This is a guest post by Peter M Vessenes, Founder and CEO, ProfitSee Inc.

Every business owner needs solid cash flow. If the cash in is more than the cash out, everything should be OK, right?  Unfortunately, many business owners believe that cashflow and profitability as measured by the Profit and Loss Report are the same. It is not.

Unless a business owner has had formal training in finance or accounting, the words “cash flow” do not mean what common English implies. Cash flow does mean measuring all the cash in against all the cash out, but accounting rules can make finding out a business’ cashflow difficult.

For those businesses using accounting software, the first challenge is understanding how the report is generated from your accounting system. Most postings in accounting software occur as they happen. So that the point at which a company creates a sales invoice, the invoice is posted in the software. This shows up under the category of “Sales”. According to the software, the posted “Sales” has been achieved even though the sales invoice has not been paid! Accounting rules require recognition of revenue and expenses when ownership of the goods or services passes. So the Sale was created by the invoice being raised immediately following the customer’s receipt of the goods. It is not posted in the accounting software when the payment of the sales invoice is received. The same is true of expenses. A company’s purchases are posted when they are received, not necessarily when they are paid.

The revenue and expense recognition rule gives us a “snapshot” of how the company’s business activity is happening. It does not give us a picture of the cashflow. Every business owner wishes their invoices are paid on the day they are sent out, and their expenses are paid on the last possible day to avoid penalties, but this is not realistic. This is why financial reports should be evaluated both from an accounting perspective (how the strategies of the company are working) and from a Cash standpoint (what is today’s reality).

Cash Flow statements must be looked at in a “Cash” profile. They should include the cash transaction that occur in the Balance Sheet and in the Equity category (such as money received from the sale of shares), if the company is still dependent on cash infusions from investors or shareholders. Accounting rules may provide you with an accurate report on profitability, but it does not necessarily provide you with all the information you need to make sound business decisions. Other information includes reviewing the Cash Flow report along with the Aged Debtors and Aged Creditors reports. This is the start of getting a clearer picture of the financial condition of the company.

Are you sure the company’s financial reports are generating all the information you require?  Take the time to meet with your Chartered Accountant to discuss cashflow as well as profitability. Financial Management is much more than accounting.

For information on ProfitSee go to their website.

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