It’s certainty a reasonable question to ask. Surely if a business has made a substantial profit then the money in the bank should have increased by the same amount?
Well, yes and no….
It’s definitely true that profits generate cash, and a business that has a successful year will usually see their bank balance rising. But - there is another factor that comes into play which some business owners may overlook:
The balance sheet.
Whilst many cash inflows and outflows go straight to the profit and loss account and have a direct impact on the annual profit figure, there are a number of things which go directly to the balance sheet.
Examples are numerous and include the following common examples:
- Loan repayments made
- Payments to purchase new company assets such as cars, vans and machinery
- Payments to trade creditors relating to older invoices
- Payments to HMRC for VAT, Corporation Tax or other taxes
- Payments to
All the above are examples of payments that are drawn from the bank, but they don’t hit the profit and loss account, they hit the balance sheet. And so business profits for the year can often be higher than the cash outflows in the same year.
Many owners of small businesses quite rightly focus on their profit and loss account to see how their business is performing, but for a better understanding the balance sheet needs to be considered too…
The next step
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