“How did I make that much profit? I don’t have that much money in the bank.”
It’s not uncommon for business owners to ask this question. But there’s a logical explanation behind it and the answer can be found in the balance sheet. It’s called ‘a statement of financial position’ for a reason.
By looking at this key financial report, you can get a snapshot of:
- what your company owns (assets) and owes (liabilities/debts);
- how much you have invested in it; and,
- why your business profit doesn’t match what’s on your bank account.
What are the common uses of business profits?
For starters, let’s take note of some common ways business owners use their profits (ie. the remaining revenue after expenses):
- Make loan repayment
- Invest in new assets
- Buy inventory
- Pay dividends
Further, where you have invoiced a customer and they are yet to pay you, the debtor amount (accounts payable) also contributes to your profit allocation.
Since business profits can manifest in many forms including the money in your bank account, the profit amount you see on the balance sheet is not the same amount you have in the bank.
Here’s a sample illustration
For example, a fictitious small business named XYZ Pty Ltd, made a profit of $25,000 for the year.
Although the profit is not sitting in the bank, the money has been used in the ongoing operations of the business.
This is illustrated in the balance sheet below:
The table above shows how to compute for the profit allocation. Get the difference between the balance sheet items of the current year (20YY) figures and the prior year (20XX) figures and you will derive the total amount of profit, which is $25,000. But how much of this amount is considered cash at the bank? Only $5,000.
So where did the rest (i.e. $20,000) of the profit go? Check the stock on hand ($2,000), unpaid debts of traders ($3,000), and repayment of bank loan ($15,000). Add them up and you’ll get the total profit of $25,000.
That’s why you don’t see all that money in your bank account. So, yes, it’s possible to have a huge amount of profit on your financial report yet have less money in your account.
Profit increases assets, decreases liabilities
As you can see on the balance sheet, you use profits to buy new assets or pay off loans or debts.
A Profit and Loss statement or income statement is another financial report that you can use specifically for profit analysis. This report contains the summary of the operating activities, revenue, expenses, and income during the course of the year.
Although the balance sheet and profit and loss statement may present different information, they are interrelated. Understanding both financial reports can empower business owners to make adjustments and better decisions to ensure success.
Do you have more questions about balancing the books? It’s always smart to seek professional help when you’re confused.
Have your books checked for accuracy and gain clarity by asking your accountant to explain how you can use the financial statements to your advantage.