Profit IS Important but Cash is the King!
The biggest value out of Accounting (as opposed to the mandatory, much hated compliance nature of Accounting which is imposed on business owners by legislation) is the ability to use Accounting in a practical manner to move forward and achieve our business goals, increase our profits.
In order to do that, we need to have a basic understanding of Accounting, required for financial planning. By that, we do not mean mastering the technical aspect of it, debits and credits, not the least.
It's true that the ordinary manager understands the meaning of some ordinary words that are used by accountants and which meets in his everyday life.
For example: Cash. Cash is a very specific and clear term that is used to explain how much money you actually have in hand to pay your expenses as they arise. It's something tangible; they can see it, touch it and count it.
But, they don't have the same degree of understanding when it comes to all those vague (but vital for the existence of your business) terms found in accounts.
The trouble is business owners cannot ignore those technical words if they want to be successful.
The reason: The market system (in which your business has its place) uses those accounting terms all the time. It makes decisions and makes assessments by reference to them and using them often to evaluate and compare business performance.
For example, Profit is one of those technical but vital accounting terms. Profit is how much is left after all the bills are taken into account. Everything is counted in terms of profit. You are the first one that does this, aren't you? You know damn well that your business will have grown when the profit is maximised and this is the goal towards which a substantial amount of your life energies including your effort and time go.
The business creditworthiness for a business loan or to get credit by a supplier is based on profitability. The amount of taxes the business will pay is based on the accounting profit. Investors assess whether to invest in a company on the basis of its profitability.
NOT ON CASH FLOW!!!
Another example of an accounting term is turnover. It means how much money comes into the business from selling the products or services but not necessarily represented by cash.
To cut it short, unless we know what profit means from a technical point of view, how can we deal with it in any possible way and give the market the assurances it needs by trying our best efforts to increase it?
Ok, understood. But, why is there a difference between cash flow and profit? Rephrasing it, what is the relationship between cash and accounting?
Let me say only one word: TIME.
Making profit doesn't always mean having the cash from your customers, as they will pay you some time in the next year (hopefully!).
The cash flow position gets even worse if you pay your suppliers before your customers pay you. That means that your profit is lowered, as you have to borrow and pay overdraft interest.
But, despite of the cash deficit, you might be trading at a profit.
The result is you look good on paper (paper profits) but you have no cash. And of course you cannot spend paper profit.
And by the same logic, if you make a short-term loss in the accounts, that doesn't necessarily, mean that you have a cash problem. That will be the case if you haven't paid yet your suppliers with the cash that you have received from your customers.
As a matter of fact, that last statement might account for the fact that a large percentage of businesses don't make it into their second year, especially for cash businesses (which give no credit to their customers). Getting the cash immediately while having say a month to pay their suppliers lead some owners to spend it because they thought cash was profit. This is the reason why it's a good idea to start your relationship with a supplier on a COD basis (stands for Cash on Delivery).
Bottom line is, profit is important and you cannot continue in business if you are trading at losses. But, that profit has to eventually been converted into cash because you won't last long either if you cannot pay your suppliers.
You can operate longer without profits than without cash.
As a small business owner, you will have to snatch your ego food anywhere you can find it. Cash flow is to your ego what a bucket of water is to a candle flame.
Ninety days after you have landed that big contract, which is sixty days after you billed that customer and 30 days after you paid your suppliers for the material you delivered to fulfil that contract, your banker will call to ask you how you are going to cover your overdraft.
Eventually, as you have guessed by now, into time and under normal circumstances, the profit is bound to be converted into cash. Unless of course the business does not make it into that timeline.
Can you see how confusing it can get? Especially for somebody who hasn't spent years studying and training on the subject of accounting and finance?
Some might be thinking: why the heck does it have to be so complicated? Why do businesses revolve around profit and not cash?
Why doesn't the market use easier to understand terms? You can read more on this subject by clicking here.
The need for that has arisen because the overwhelming majority of businesses in the world do not collect debts from their customers the same day they sell, far from it. They don't pay suppliers the same day they purchase from them; they take even longer than time to get paid from their customers. And stock is not converted into cash or sales on the day of production but lies around waiting to be converted into debt and then cash. Can you see that it's all down to one word: TIME.
People needed some common fundamental basis, some common language to measure performance. That is absolutely necessary and vital if meaningful comparisons can be made between businesses.
We cannot have one business recognising as income only money received in 6 months and another money received in 12 months. And we cannot have a business use the cash basis for recognising sales and the one next to it money received and owed (i.e. invoices issued in the year).
So, what is that common basis?
Recognise income and expenses in the year in which they have occurred, i.e. when the goods have been despatched or the service provided, irrespective of when the money is received or paid. This is the basis on which accounts are prepared.
This is the meaning of TIME in business.
Can you see now how crucial it is to make sure that you get hold of and understand the information contained in the accounts, no matter what it takes?
You see that your business' success very much depends on those words.
Bottom line is that information prepared using the principles described above must be obtained, albeit away from jargon and in an understandable form so that easier and better business decisions can be made by the average business owner who doesn't hold a degree in accountancy..
This is where accountants come in. Accountants can do an expert and close to perfection job in support of a small business at an affordable cost. Accountants are not only middlemen between you and the Government but they have the necessary knowledge, training and experience to help you grow your business.
If you want to read more on the topic of how an accountant can assist you towards growing your business and increase profits, please click here.
Please feel free to use all the information that you will find on the web site.
If you have questions, please feel free to contact me personally at any time. You can call, e-mail, fax or write to me and I will be happy to answer any and all of your questions.
Good luck in your business ventures!
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