Can I explain a huge source of money confusion? Read for a💡moment.

Here’s one of the most confusing things about money that business owners have to wrap their minds around.

The profit and loss statement, or income statement, is a report that summarizes income and expenses over a certain time period.

It tells you if you’re profitable, but it doesn’t tell you if you were able to keep any of those profits.

🤔 Huh?

It happens because of accounting rules that make good theoretical sense.

But in practice, you have to know about them so you can understand why your p&l shows you’re making money even though your bank balance isn’t growing.

Here are three common reasons that might be happening:

Loan payments: loan payments for equipment, vehicles or other assets have two parts. Principal, which is paying back the money you borrowed; and

Interest, which is the cost of borrowing money

Only the interest portion is an expense on the p&l- the principal part doesn’t show up! So if you have a $700 monthly payment and $100 is interest, that’s $600 per month in cash going out that’s not reported on the p&l.

Owner draws: as the business owner, if you pay yourself using a payroll service, those amounts are expenses on the p&l. If you pay yourself using distributions, shareholder withdrawals, or by paying personal expenses with business funds, those payments don’t show up on the p&l.

So if you make a $1,000 payment directly from the business account to your personal credit card, that’s $1,000 out the door that’s not on the report.

Cash vs accrual. This one’s a little more advanced, but the simplest way to understand it is to think about timing differences between when you report income and when you actually receive cash.

If you send an invoice for $5,000 today, that’s the trigger for income using accrual accounting. When the cash is received 2 weeks later, that’s the trigger for income using cash accounting. If you run an accrual basis p&l on day 7, it shows that you’ve made $5,000 more than you have in the bank.

Tricky right?

If you have any of these three situations, file this email away for the next time you review your p&l. And of course, make sure you’re getting your bank accounts reconciled every month! It will help you stay on top of your cash flow and catch any mistakes right away.

If you need help with that, don’t hesitate to reach out!