I work with business owners of varied educational background.  Even if they have had a formal business class, it’s sometimes been a while. Discussions regarding the difference between profitability and cash flow are frequent.  Let me explain with a very simplified example.

In January, you purchase $1000 worth of paper to make and then sell origami swans.  You have to pay staff, rent, and utilities, too.  Let’s say that’s another $2000.  We have spent $3000 so far.  On January 31, we sell half the origami swans we made for $4000.

At this point, we show a profit of $1000.  We have $4000 in sales and $3000 in expenses for a net profit of $1000.  We don’t actually have that money yet.  The customer who bought the product will pay us in 15 days.  Cash flow is not positive until February 15th when the client pays us.  We have had to invest a bit before making money.

Another simple example is an asset purchase.  I buy a new paper folder for my origami swan business for $5000 cash.  This is a large purchase that has value that I could sell.  I can’t not expense the entire purchase price of the folding machine…it is going to be depreciated over 7 years.  My bank account will reflect that $5000 went out, but there is not a $5000 expense to match.  I will only be able to expense $1200 this year for the machine.  Net result is $5000 less is cash, $1200 more in expenses, and we have about $3800 in assets.

Surely, every business needs to review the Profit & Loss (Income Statement) frequently.  But you must also realize that this reflects only part of the financial status of your business.  The P&L Report must be used in tandem with your Balance Sheet report to get a more accurate picture.  Both of these reports can be run quickly in QuickBooks anytime.