This is a question we get asked very often. How can my business be making a profit if there is no money in the bank?
Understanding the difference between profit and cash in the bank is essential for any business owner in Australia. While both are vital indicators of a business’s financial health, they represent different things and serve different purposes.
In simple terms, profit is the money left after a business has deducted all its expenses from its income. It is usually calculated over a specific period, such as a quarter or year, and expressed as a percentage of revenue or earnings.
On the other hand, cash in the bank refers to the actual money a business has on hand in its bank accounts, including current, savings, and money market accounts. This liquid asset can be used to pay expenses, invest in the business, or distribute dividends to shareholders. Cash can come from various sources, including sales revenue, loans, investments, or other financing activities.
It is important to note that profit and cash are related but not the same thing. Profit does not necessarily equal cash because there can be a delay between earning revenue and receiving payment. For instance, a business that offers credit terms to its customers may not receive payment for several weeks or months, even though it recognises income in its books. In this case, the business may have earned a profit, but it may not have the cash on hand to pay bills or invest in its operations.
Conversely, a business may have cash in the bank but not be profitable if it spends more money than it earns consistently. This situation can occur when a business uses its cash reserves to cover losses or invest in growth initiatives that have not yet generated a return on investment. In this case, while the business has cash on hand, it may not be sustainable in the long run if it cannot generate a profit.
To summarize, profit and cash are essential metrics for measuring a business’s financial health, but they represent different things and should be evaluated separately. Profit measures a business’s ability to generate earnings after expenses, while cash measures its liquidity and ability to pay its bills and invest in its operations. In Australia, businesses should prioritize understanding both profit and cash and managing them effectively to ensure long-term success.
