Starting a business can be quite a rollercoaster with its ups and downs. Many new entrepreneurs face a challenge when they realise that the anticipated profits are not reflected in the actual cash available at the end of the financial year. This guide addresses these concerns by identifying potential areas where your expected revenue may not materialise.
Possible causes of missing profits
Your business may have demonstrated strong performance over the year, but there is little cash to reflect it for various reasons. Here are a couple of potential areas where your profits might be hiding despite the excellent performance:
- Unsettled debts: Some customers may have received your products or services without paying.
- Inventory: Your profits may be held up in unsold inventory or raw materials, particularly if you purchase large quantities.
- Asset acquisition: If you’ve acquired new assets, such as a work vehicle, these expenses are spread out over several years through depreciation rather than being fully claimed in the year of purchase.
- Owner withdrawals: Balancing the amount of profit you withdraw from your business for personal use can be challenging.
Navigating financial statements
Your profit and loss statement is a crucial aspect of comprehending your financial status. This report illustrates your company’s revenue and costs during a specific timeframe, regardless of whether the transactions have been finalised. This implies that sales or purchases made on credit are considered, leading to a potential mismatch between your profit numbers and the available cash.
Bridging the gap
To ensure that your financial statements accurately reflect your financial position, you must examine the amounts owed to you regularly. It’s crucial to stay diligent in pursuing payments and implementing measures for overdue payments. Furthermore, utilising a cloud-based accounting platform to monitor real-time transactions can facilitate prompt decision-making.
Dealing with creditors and debtors
Businesses frequently deal with customers who make purchases on credit and suppliers who extend credit terms for purchases. This situation can delay recording transactions and actual monetary exchanges, causing an increase in the amounts reported under ‘Sales’ and ‘Cost of Goods Sold’ (COGS), even though the funds in your bank account stay the same.
Understanding COGS
COGS represents the direct expenses related to producing or obtaining the products you offer to customers. This encompasses the initial stock, purchases during a designated timeframe, and the remaining inventory at the conclusion of that timeframe. Additional expenses such as shipping, storage, and manufacturing overheads may also be included.
The role of reinvestment and owner withdrawals
To bolster their growth, companies often channel their earnings back into the operation, which might involve enhancing inventory, increasing the number of debtors, or investing in capital projects. However, hefty payouts to owners can hinder this growth and drain the available cash reserves. Therefore, it’s vital for each proprietor to implement prudent budgeting to curb the temptation of withdrawing profits excessively.
The Bottom Line
If you find yourself approaching the end of the fiscal year with profits but insufficient cash on hand to cover your taxes, there’s no need to worry. Take a close look at your financial records to determine if your available money is held up in excess inventory, outstanding customer accounts, or newly acquired assets. Running a business is a continual learning experience, and gaining insight into these financial complexities will enable you to manage it more effectively.
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