You checked your business bank account and breathed a sigh of relief. There’s money there. Bills are getting paid. Payroll is covered. Things must be going pretty well, right?
Maybe.
One of the biggest misconceptions we see among business owners is that having money in the bank automatically means the business is profitable. Unfortunately, it’s not quite that simple.
Your bank balance tells you how much cash you have at that exact point in time. Profitability tells you whether your business is actually making money after all of your expenses are accounted for.
Those are two very different things.
So, where did the money go?
Let’s say your business brought in $500,000 this year. That sounds pretty good, right?! But then you subtract payroll, rent, insurance, utilities, software, supplies, equipment, loan interest, professional fees, and all the other costs that come with running a business.
Suddenly, that $500,000 doesn’t look quite as impressive.
And even if you are profitable, you may not have $50,000 or $100,000 sitting in your bank account. You may have outstanding customer invoices, recently purchased equipment, loan payments, taxes due, or other obligations that affect your available cash.
This is why simply checking your bank account isn’t enough to understand how your business is doing.
Revenue isn’t the same as profit
These are the two numbers business owners need to understand.
- Revenue is the money your business brings in from selling your products or services.
- Profit is what’s left after you pay the expenses required to operate the business.
For example, if you have $50,000 in sales but spend $45,000 to generate those sales, your profit isn’t $50,000. It’s closer to $5,000 before considering any additional expenses that may apply.
Growing revenue is great. But if your expenses are growing just as quickly (or faster), you could find yourself working harder without actually making more money. More sales don’t automatically equal more profit.
And then there’s cash flow
This is where things can get even more confusing. A business can be profitable on paper and still have trouble paying its bills.
Imagine you completed a large project and sent your customer a $40,000 invoice. That $40,000 may show up as revenue on your books, but if the customer doesn’t actually pay you for 60 days, you don’t have that cash available to pay this month’s bills.
On the other hand, you might have plenty of cash in the bank because you recently took out a loan or received a large customer payment. That doesn’t really mean your business is particularly profitable, though.
Cash is about timing. Profit is about performance.
It’s important business owners understand both.
What should you actually be watching?
You don’t need to become an accountant to understand the financial health of your business. But you do need to pay attention to a few key numbers. Let’s take a look below:
Gross profit – Gross profit shows you how much money is left after the direct costs associated with producing your product or delivering your service. This can tell you a lot about whether what you’re selling is priced appropriately.
Net profit – This is what’s left after your operating expenses are paid. If your sales are increasing but your net profit isn’t, that’s a sign worth investigating.
Accounts receivable – How much money are your customers currently sitting on? If you have $100,000 in unpaid invoices, that’s money you’ve earned but don’t currently have available to use. Slow-paying customers can create a serious cash-flow problem, even when sales look great.
Your expenses – Are your expenses increasing faster than your revenue? Sometimes it’s not one huge expense causing the problem. It’s a collection of small increases that add up over time. That monthly software subscription you barely use? The equipment you’re financing? The extra overtime? The small purchases that don’t seem significant individually? They ALL count.
Cash flow – Finally, look at what’s actually coming into and going out of your bank accounts. Understanding your cash flow helps you anticipate problems instead of discovering them when the bank account gets uncomfortably low.
Your financial statements can tell you the story
This is one of the reasons accurate, up-to-date bookkeeping matters so much. Your financial statements aren’t just reports your accountant looks at once a year. They tell you what is happening inside your business.
- Profit and loss statements help to see whether you’re actually making money and where your money is going.
- Balance sheetsgive a snapshot of what your business owns, what it owes, and what’s left for the owners.
- Cash flow informationhelps you understand the movement of money through the business.
When these numbers are current and accurate, you have something much more valuable than a report. You have information you can use to make decisions.
So, is your business actually profitable?
If your immediate answer is, “I think so?” that’s probably worth exploring the following:
- Take a look at your year-to-date numbers.
- Compare your revenue to your expenses.
- Check your profit margin.
- Look at your outstanding invoices.
- Review your cash flow.
And don’t just look at the numbers, look for the story they’re telling you. Maybe your business is doing great and there are a few areas that need attention.
Or maybe you’re working incredibly hard, bringing in plenty of revenue, and still not keeping as much of it as you should. That’s not a failure. It’s information. And good financial information gives you the opportunity to make better decisions.
At Knecht Business Solutions, we believe bookkeeping should be more than keeping your books organized. Your numbers should help you understand your business, make informed decisions, and plan for what’s ahead. Schedule a consultation today and we can take a closer look at what your numbers are telling you!