In business, there are hundreds of ways to measure the success and health of a company. So many that it can be confusing and slow down your business.
That's why having the right grasp of what is needed for your company and what you could probably eliminate is very important. We want to simplify business, not complicate it.
After a few years of running a business, we quickly learn the importance of knowing and measuring our results. It's what ultimately tells us how the business is doing and where it is trending.
But not having the right tools to find out if a business is healthy or not can cause serious consequences.
This is where profit and loss and cash flow matter. Both seem very similar but they play two very distinct roles. When utilized together, they can become very powerful and effective tools.
The workplace comic, Dilbert, puts this in perspective in a strip talking about strategy. The executive says, “We need a clear strategy. Does anyone have a suggestion?” Dilbert turns and responds, “Let’s figure out what makes the most profit. And then do more of it.” The executive quickly responds, “It needs to be less clear than that.”
In a hilarious satirical state of organizational strategy, Dilbert points to one very specific thing. To grow our business, we need a very clear roadmap on how to get there. One of the best ways we can do that is by understanding our financial statements and using them to measure the success of our company to plan for the future.
In this article, we’ll explore and remind ourselves what a Profit and Loss statement and a Cash Flow statement is. After, we’ll review the difference between the two. Finally, we'll go through a practical scenario that helps shed light on how we can use them symbiotically for the benefit of our business.
Commonly referred to as P&L, Investopedia, defines it as “…a financial statement that summarizes the revenues, costs, and expenses incurred during a specified period, usually a fiscal quarter or year.” The definition also continues to say it is synonymous with an income statement.
In short, the Profit and Loss statement is the best way to get a snapshot of what your business is earning and spending. It's based on a static time cycle or period and it is used for reporting and looking into the past.
At its basic level, the equations for a P&L statement is Revenues – Expenses = Profit.
Here’s what a simplified P&L might contain. (This is not accounting advice, only a visual example.)
Joe’s Consulting Inc.
October 1- December 31, 2019
Total Revenue $120,000
Cost of Goods Sold $32,000
Total Operating Expenses ($52,000)
Gross Profit $68,000
Total Overhead ($19,000)
Operating Income $49,000
Earnings before taxes $49,000
Net Income $37,500
Depending on the stage of your business, you may require a more in-depth statement, however, this gives you an idea of what to expect and look for in a P&L.
This can be a favorite for business owners because it answers the practical question of “what is in the bank right now?". Cash flow refers to the flow of money.
Investopedia defines it as “… a financial statement that provides aggregate data regarding all cash inflows a company receives from its ongoing operations and external investment sources.” In other words, it’s a financial statement that measures and tracks the incoming and outgoing of your company’s cash.
Why is this important?
- If customers buy your product or service but fail to pay in time, you need to know because it's not going to be reflected in your bank account.
- When your business pays expenses, rent, and other costly commitments, it might not be able to pay everything all at once. Managing your cash flow helps space out the time to balance the earnings coming in, and when you can pay for bills.
A Cash Flow is simple yet a very necessary process. 82% of businesses fail because of poor cash flow management. They can be making a profit, but if there isn't enough cash in the bank when they need it, they might never see it before closing the doors for good.
Cash Flows don’t have to seem so dark. They can be liberating and give you control over how the business operates. Wouldn’t you feel much better if your cash was managed so well that you didn’t have to worry about it every day?
Here is a basic example of the kind of numbers you will find in a cash flow statement. (This is not accounting advice, only a visual example.)
Lulu’s Tiki Gift Shop Inc.
Cash Flow Statement
Month Ended March 31, 2020
Operating Cash Flows
Cash received from customers $20,000
Cash paid for marketing ($6,000)
Net Operating Cash Flows $14,000
Investing Cash Flows
Purchase of Inventory ($3,000)
Net Investing Cash Flows ($3,000)
Financing Cash Flows
Cash paid for loan repayment ($2,000)
Net Cash Flow from Financing ($2,000)
Net Increase in Cash $9,000
As you can see, Cash Flow is all about what’s happening now. It follows the money, how much is coming in and how much is going out.
Now that we know what both types of statements mean for a business, it's time to compare them. After going through this article, you might already have an idea. If not, then that's alright too. Together, we'll identify some key differences.
Measures the actual profit of the business vs. its losses
It functions more as a static report about the past term
It measures reported gains and losses, not necessarily where the cash is
It follows the flow of your money
It doesn’t necessarily measure your profit and losses, but the amount of money in your account and the amount leaving it at the given time
While still a report, it functions more as real-time, since business is constantly measuring and balancing the flow of its money
Profit and Loss Statement is great for looking back and measuring the growth of the company, especially when comparing it quarter by quarter or year by year.
Cash Flow Statement is great for the operational, real-time side of the business and the movement of cash.
It’s great to know what both statements are, but it can be hard to put them into practice and know the difference.
The best way to explain it is by looking at a short example or case study.
Imagine you are a consultant that negotiated a very specific payment structure. For three months, you want to deliver multiple services to the same client. You set up a fair structure for both you and the client.
25% of the bill is paid at the start of the contract in the first month. For the second month, 50% of the bill is paid since it includes the majority of the work delivered at that time. The third month is realized when the last 25% is paid at the finalization of the project.
Let’s say that your Profit and Loss Statement is quarterly.
100% of the service will show as revenue for that period. You know that you had a good quarter and you made a certain amount of profit. You can now compare it to the last quarter and possibly forecast the next one.
Since the payments are broken up, you have some planning to do.
Your income will be considerably less the first and last month of the project. Your P&L doesn't reflect it. This is where your monthly Cash Flow can help plan out how much cash you will have access to throughout the scope of the project. Instead of dealing with a bad month or a difficult cash period, you can plan your business operations around the cash flow.
Both statements can be powerful for your business. Learning how to use them puts you ahead of the game and puts you in control of the business, not the other way around. Once you start using these tools, you'll feel a sense of freedom knowing the health of your business.
Now that you have a grasp of what a Profit and Loss and Cash Flow Statement are, you can begin to utilize both to benefit the company.
Running a business can be hard.
Sometimes it feels like you are working “in” it and not "on" it. That's why a platform like Profit Frog makes business simple, allowing you to measure the impact of your business decisions in an easy, practical way. Curious about your profit and loss and how some changes can impact your business? Profit Frog lets you try it out before you take the leap.