If you’ve ever looked at the profit your business is generating, you may have noticed that the profit appears much higher than your bank balance.

Why is that?

There are three common reasons that you might have less cash than profit.

1. Owner Draws

If your business is a sole proprietorship or single-member LLC, you may have taken funds out of the business to pay your personal expenses and would-be salary. This is considered profit to the business.

This is often how business owners start receiving the benefits of their business’ success. Once profit reaches a certain level, you may be able to save 5-20% on income taxes by converting to an s-corporation. We help people make this transition.

2. Accrual Accounting

Business financials can be tracked and reported in one of two ways: Cash Basis or Accrual Basis.

Cash basis accounting is most commonly used for small business tax reporting. It relies on recording information “upon cash receipt” rather than upon commitment.

Accrual basis accounting records transactions upon commitment. It is more useful to business owners in understanding the financial health of their business. However, if you view your income statement on accrual basis, it will show you revenue that may not have been received, therefore inflating your profit compared to your bank balance.

For example, let’s say a new customer is invoiced $2,000 for a product order. Under cash accounting, the funds will be recorded to the income statement when they are received by the business. Under accrual accounting, the funds are recorded the moment they are invoiced, regardless of when the invoice is paid.

3. Purchase of Assets

Assets are depreciated over time so they do not appear on your income statement to directly reduce profit. Utilizing profit to purchase assets is a great way to re-invest in the business, but it is one of the ways that the bank balance can be lower than profit.

The Truth About Your Bank Balance

Your bank balance is unreliable. Period. If you take anything from this article, it should be that you cannot rely on your bank balance to tell you how much you can spend in your business.

You absolutely need to utilize financial statements to understand the financial health of your business. The sooner you begin, the better your short- and long-term results will be.

I can’t emphasize enough that the most common problem we see from small business owners in the hemp industry is not using the data their business generates to make daily spending decisions.

There are many reasons you might not be using your data to make more effective decisions:

-You don’t know how to create useful reports or your accountant doesn’t provide them

-You think you have a grip on your cash flow without referencing reports

-You are overwhelmed with your accounting software

Don’t let one of these issues cause you to make a big budgeting mistake. If your accountant is not providing you with insightful financial data, find a new accountant. We work directly with our clients to help them understand their data and use it to make effective decisions. To schedule an appointment with us, email hello@sonderaccounting.com