This is a shorter than normal blog however the topic is one that needs to be understood by all business owners, particularly small business owners who are new in the field or still growing their business. I cannot count the number of times I have heard people state “based on my cash balance, my business is doing really well!” Or, “I had a huge net profit this year, so my business has surplus money to spend!” While each statement might be correct, they might also be incorrect. Understanding what each item reflects is crucial in making business decisions. Let’s take a quick glance at each and the story it tells us.
Cash Balance:
The cash balance shows the funds the business has, that is net funds received and funds spent. The cash balance does not say anything about the business’s operational performance. When a business needs to see what it has available to spend or invest, it needs to examine its cash balance. A high cash balance does not necessarily mean the business performed well. The business may have started the year with a high surplus of cash in the account, or it may have received a large grant or a settlement during the year. There are a number of reasons why the cash balance might be high.
Note: If the business uses the accrual accounting method, it is important to subtract out the accounts receivable balance and add in the accounts payable balance to get a more accurate view of its cash balance.
Net Profit:
While the cash balance reflects a business’s available funds for spending, the net profit shows how well operationally the business performed for a given period of time. A great operational year does not immediately translate to a large cash balance. Say for example, at the end of the year the business spends a large portion of its cash on purchasing inventory and the net profit is $1M. Management should not assume that the $1M of net profit automatically implies that the cash balance is somewhere around $1M also.
In summary, to know how the business has performed, look at the net income line, which could show a profit or a loss. To look at what spendable funds the business has, look at the cash balance. Understanding the difference between your business’s cash balance and net profit is crucial. Hopefully the blog has helped to clear up any confusion you had concerning if your business’s cash balance = net profit.
DISCLAIMER: The information provided herein does not constitute the provision of legal advice, tax advice, accounting services, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional legal, tax, accounting, or other professional advisers. Before making any decision or taking any action, you should consult a professional adviser who has been provided with all pertinent facts relevant to your particular situation and for your particular state(s) of operation.
