Cash flow · 2 min read ·
Is your business actually making money?
Profit on paper and money in the bank are different things. How to tell which one you have.
The tax return says you made money. The bank account says otherwise. Both are telling the truth, and until you know which question each one answers, you cannot tell whether the business is working.
Three different questions
Did the business earn more than it spent this year? That is profit, and it is what the P&L and the tax return measure. Did more money come in than went out? That is cash flow, and it includes loan payments, equipment purchases, owner draws and tax deposits that never touch the P&L. Is the business worth more than it was a year ago? That is the balance sheet. An owner who only reads the first one is flying with one instrument.
The owner's pay problem
Many owner-run businesses look profitable because the owner is underpaid. If you would have to pay a manager $120,000 to do your job and you are drawing $60,000, the business is $60,000 less profitable than the statement says. Pay yourself a market wage on paper, even if you leave it in the company, and you will finally see the real number. Buyers and banks will do this math for you either way.
Where paper profit disappears
Loan principal is paid with after-tax cash but never appears as an expense. Equipment is paid for today and written off over years. Inventory ties up cash the day it arrives and shows as cost only when it sells. Receivables count as revenue the day you invoice. Each of these is a place where the P&L says money and the bank says not yet.
How to know for sure
Read the three statements together, every month, with someone who can explain them in plain English. Compare profit to the change in your bank balance and make the difference account for itself, line by line. That reconciliation is the honest answer to the question in the title. If we cannot explain it to you in a sentence, we have not done our job.
What to do with this
- Profit, cash flow and net worth answer three different questions. Read all three.
- Pay yourself a market wage on paper to see the real profit.
- Loan principal, equipment, inventory and receivables are where paper profit hides.
- Reconcile profit to the change in cash every month.
Questions this answers
Profit is revenue minus expenses for a period, as the P&L measures it. Cash flow is the money that actually moved, including loan principal, equipment, inventory and owner draws that never appear on the P&L.
Pay yourself a market wage on paper, then compare the profit on the P&L to the change in your bank balance and account for every difference. If the business is ahead after that, it is making money.
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