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If your profitable business has trouble making ends meet, it\u2019s not alone. Many business owners mistakenly equate profits with cash flow, leading to shortfalls in the checking account. The truth is that there are many reasons these numbers might differ.<\/p>\n
Fluctuations in working capital<\/strong><\/p>\n Profits (or pretax earnings) are closely related to taxable income. Reported at the bottom of your company\u2019s income statement, they\u2019re essentially the result of revenue earned minus operating expenses incurred in the accounting period. Under U.S. Generally Accepted Accounting Principles (GAAP), companies must \u201cmatch\u201d costs and expenses to the period in which the related revenue is earned. It doesn\u2019t necessarily matter when you pay for a product or service.<\/p>\n So, inventory items that are in progress or are completed but haven\u2019t yet been sold can\u2019t be deducted \u2014 even if they\u2019ve been long paid for (or financed). The cost hits your income statement only when an item is sold or used. Your inventory account contains many cash outflows that are waiting to be expensed.<\/p>\n Other working capital accounts \u2014 such as receivables, accrued expenses and payables \u2014 also represent a difference between the timing of cash outflows and the matching of expenses to sales. As businesses grow and prepare for increasing future sales, they need to invest more in working capital, which temporarily depletes cash.<\/p>\n Capital expenditures and financing transactions<\/strong><\/p>\n Working capital tells only part of the story, however. Your income statement also includes<\/em> depreciation and amortization, which are noncash expenses. And it excludes<\/em> capital expenditures and financing, which both affect your cash on hand.<\/p>\n To illustrate, suppose your company purchased a new piece of equipment in 2022. Expanded bonus depreciation and Section 179 allowances permitted your company to immediately deduct the purchase price of the equipment, which lowered its taxable income for 2022. After making a modest down payment, the remaining amount of the purchase was financed with debt, so actual cash outflows from the investment were minimal in 2022. Throughout 2023, your company has been making loan payments, and the principal repayment portion of these payments reduced the company\u2019s checking account balance but not its profits.<\/p>\n Capital contributions, dividends and stock repurchases<\/strong><\/p>\n You also can link discrepancies between profits and cash flow to owners\u2019 equity accounts. For example, owners might pay out dividends based on their personal financial needs, regardless of whether the business is profitable.<\/p>\n Dividends (or distributions) paid to owners lower cash on hand, but they have no effect on the profits reported on the company\u2019s income statement. Likewise, additional capital contributions and stock repurchases will hit the company\u2019s checking account without affecting profits.<\/p>\n Efficient cash flow management<\/strong><\/p>\n It\u2019s important for business owners to understand the key differences between profits and cash flow. Some growing, profitable companies will experience cash shortages. And some mature \u201ccash cows\u201d will have ample cash on hand, despite lackluster revenue growth. If your business is facing a cash crunch, contact us for help devising strategies to improve cash flow. We can help your business pay its bills on time and find resources to seize value-building opportunities.<\/p>\n \u00a9 2023<\/em><\/p>\n <\/body> If your profitable business has trouble making ends meet, it\u2019s not alone. Many business owners mistakenly equate profits with cash flow, leading to shortfalls in the checking account. The truth is that there are many reasons these numbers might differ. Fluctuations in working capital Profits (or pretax earnings) are closely related to taxable income. Reported […]<\/p>\n","protected":false},"author":3,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[13,7,10],"tags":[8,11,12],"class_list":["post-16617","post","type-post","status-publish","format-standard","hentry","category-aa","category-articles","category-news","tag-articles","tag-news","tag-updates"],"_links":{"self":[{"href":"https:\/\/www.sfw.cpa\/news-and-guides\/wp-json\/wp\/v2\/posts\/16617","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.sfw.cpa\/news-and-guides\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.sfw.cpa\/news-and-guides\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.sfw.cpa\/news-and-guides\/wp-json\/wp\/v2\/users\/3"}],"replies":[{"embeddable":true,"href":"https:\/\/www.sfw.cpa\/news-and-guides\/wp-json\/wp\/v2\/comments?post=16617"}],"version-history":[{"count":1,"href":"https:\/\/www.sfw.cpa\/news-and-guides\/wp-json\/wp\/v2\/posts\/16617\/revisions"}],"predecessor-version":[{"id":16618,"href":"https:\/\/www.sfw.cpa\/news-and-guides\/wp-json\/wp\/v2\/posts\/16617\/revisions\/16618"}],"wp:attachment":[{"href":"https:\/\/www.sfw.cpa\/news-and-guides\/wp-json\/wp\/v2\/media?parent=16617"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.sfw.cpa\/news-and-guides\/wp-json\/wp\/v2\/categories?post=16617"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.sfw.cpa\/news-and-guides\/wp-json\/wp\/v2\/tags?post=16617"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}
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