Profit & Loss: Where did the money go?
This is the age old accounting question asked by business owners when reviewing their small business financials. I Googled this question, and it’s everywhere. We are all trying to answer it. But, from my experience, we aren’t getting to the answer entrepreneurs want. Let’s go through the process.
We should start with the basic vocabulary of the Profit & Loss (or P&L), beginning at the top:
Sales = Income
Cost of Goods Sold = What you spent producing your core business
Expenses = What you spend on everything else (overhead, etc.)
Net Income = How much money you made after paying all the bills.
Sounds easy, right? However, many business owners we meet show profit on their P&L, and have no money. Herein lies the question we get, “Where did the money go?”
We will step through this bit by bit, and I’ll simply invite calls and comments to better explore your individual situation. I look at financial statements often, and don’t want to skip anything, but in this situation, I’m sure it is inevitable.
First, let’s look at a foundation question in financial planning and analysis: do you do your books on an accrual or cash basis? While these should be about the same over time, it isn’t always true. QuickBooks has a simple button that lets you switch between accrual and cash basis, so comparison is easy.
Let’s define accrual basis and cash basis, so we don’t skip a step:
Accrual Basis: accounting for A/R as you send invoices out, and accounting for A/P as bills come in.
This doesn’t tell you anything about actual money in the door, nor bills you actually paid. If you have a stack of unpaid bills, your profit will show up much lower than the money you have, as the system assumes you pay the bill the moment it is due.
Cash Basis: accounting for money as it actually moves. So, if you have a stack of unpaid bills, these won’t show up as profit killers, because money hasn’t moved.
This forced choice may be where some of the money has gone. If your business is over about $5M / year, you are not allowed to file on a cash basis, so that may help you know where you sit.
Next, we consider what purchases go STRAIGHT to the balance sheet, and never hit the P&L as an expense.
- Amortizing Assets. Picture that you bought a work truck for $35,000. The first year that truck is in service will only reflect a portion of the cash spent in the P&L, and the entire asset will be on the balance sheet. This is true for building purchases, office remodels, some websites and most equipment priced over a few thousand dollars.
- Research & Development Costs. This expense doesn’t hit the P&L until the new product hits production. If you are doing R&D, you need to create reporting around it, so you can manage the cost like a small business within your business. R&D sits on your balance sheet as an asset, and you should be creating intellectual property.
- Debt Repayment. Interest payments are an expense. The principle repayment is not. It decreases a liability of the balance sheet, but will not show up elsewhere. The purchase you got on the front end wasn’t income, either.
The financial statements are a huge piece to understanding your business. In many small businesses, it is the most reliable measurement tool in the building. However, if you only use the P&L, you are only looking at a portion of the picture. There can be gaping holes in “where did the money go.”
To help manage, you can create a few accounting reports that help you manage the business that include more than the P&L and Balance Sheet. We suggest creating a detail of your bank balance, current bills, aging receivables, and a few others depending on your product or service. This should help make financial management for small business an easier goal to achieve.
About the Author Barb Fisher
Barb is the CEO of Fisher Bookkeeping, an outsourced bookkeeping consultancy that provides small businesses with a full-service financial department. Her favorite aspect of work is to break down the accounting to meaningful bits, so entrepreneurs can make a powerful difference in their own business. She's also a power lifter (squat: 215, DL: 270).