In: Accounting
Bill has a small printing business. His accountant, Charles, asked Bill to come to his office to discuss his end of the year financial statements. Charles, knowing that Bill was having a difficult time operating the printing business, showed him his income statement. Revenue is up and so is his profit but cash flow is poor.
Bill exclaimed, "I made a net profit of $80,000 that I have to pay taxes on??? You are kidding right? There is no way!!! I don't have enough money in the bank this week to pay rent. How is this possible?????"
Pretend you are Charles (the accountant) and explain how it is possible for Bill's business to show a net profit with increased revenue but not have much money in the bank. Be very thorough with your answer. This happens quite often with small businesses.
A company may earn profit however not have cash because profit is computed using revenue and expenses that is different from the company's cash receipts and cash disbursements. An effective cash flow means that the pattern of income and spending in a company allows it to have cash available to pay bills on time. Due to these reasons the inflow and outflow of cash need careful management and monitoring.
Bill's business to show a net profit with increased revenue however not have much money in the bank can be due to the following reasons:
-- Bill is not keeping track of the accounts receivable and following up on late payments
-- Bill is not availing credit from his suppliers
-- Bill might not be sending out invoices promptly, poor follow up procedures or poor credit checks.
-- Bill is not setting aside money to pay the tax man
-- High loan repayments by Bill
-- Bill might be taking more money out then the business is making