Have you ever noticed that your profit and loss statement doesn’t really align to your bank account? Are you thinking you might be going crazy? The answer is NO! you are not going crazy. There are big differences between P&L and cashflow. Here are some of them and how to make sure you work on understanding them and your financial position:
Revenue
While you might be showing a positive revenue line in your profit and loss, your bank account might be not showing the same amount of inflows. The reason is that you can recognize revenue even though your customers are not paying you. From an accounting perspective (in an accrual basis), you can work on recognizing revenue based on the below definition
Revenues are recognized when they are realized or realizable, and are earned, no matter when cash is received. In cash accounting – in contrast – revenues are recognized when cash is received no matter when goods or services are sold.
As the examples shows, it doesn’t have to align to when you receive your cash. Lets give you a proper example that might show some further light on this:
You sold AUD 10,000 worth of services to ABC Pty Ltd, the amount is due in 60 days however under accrual accounting you can recognize the revenue straight away. Hence your P&L and cashflow statement will be de-aligned.
This is something that happens quite a lot, and not only to SMEs but companies of all sizes so don’t feel like you might be doing something wrong.
However the main difference is that big companies have large financial teams that reconcile these statements hence allowing the management to understand their true financial position, SMEs…. not so much.
Costs:
Under the same accrual accounting basis you can defer expenses, payments and reduction to P&L in particular ways without any accounting issues. This might cause you to see an expense on the P&L but not on the bank account or the other way.
What Now?
Both the Profit and Loss and cashflow statements should have differences, and that is why they are separate statements, but how can you as an SME owner be on top of what is your true financial position?
- Take the hard way home: instead of working on an accrual basis work on a cash basis. This allows you to be representing your true position no matter what. (Double check with your accountant)
- Do a monthly P&L- Cashflow reconciliation: this is something that we recommend in order for you to keep track of what you are missing or adding up. Your accountant can help you doing this, and it basically enables you to reconcile why there is a difference between the P&L and the bank account. Consequently enabling you to make better informed decisions.
- Check your balance sheet:This might sound too technical but it shouldn’t be, even if you are not financially savvy you can ask your accountant/CFO to give you a monthly summary of the biggest movements on your balance sheet. This will give you the missing picture on your financial position.
- Ratios, Ratios and More Ratios: Establish particular ratios that can enable you to see if there is any issues with your cashflow, P&L or Balance Sheet.
These four steps might look like hard work, they are really not. Some of them have an immediate consequence in your business, others is more a reporting tool than an actual change. Either way we recommend you talk to your accountant about what type of accounting method are you using and how can you use what you have at the moment to improve your understanding of your financial position.