"David," Tina said [actual business coaching client, but not her real name], "We're really struggling to meet our payables this month but we have over $700,000 in profit year-to-date, how can this be happening to us? This is not something we've experienced before."
That's when I had to share with her a tough truth most business executives don't understand - your company's profit and loss statement lies.
Okay, that is perhaps a strong way to state it, but if you've ever been like Tina, or me for that matter, and looked at a strong profit showing on your P&L print out, only to later look at your bank balance and see a big discrepancy, you'd feel let down by your profit and loss statement too.
Here are five ways your profit and loss statement can mislead you (and why you need to be financially savvy enough to understand how to see the complete picture that is only clear by looking in combination at your P&L, balance sheet, and statement of cash flows.)
1. Your P&L doesn't include all aspects of cash flow.
For example, when you buy raw materials to make more inventory, this costs cash, but you don't show this cash outlay on your P&L until you sell the inventory (or write it off) for which you spent this cash. Only at that point do you get to include this cash outlay in your "cost of goods sold".
"What a minute David, are you telling me that I don't put the $273,000 I spent to make or buy my inventory in as an expense until I sell or write off that inventory?"
Yes. (To be fair to the accountants, there are good reasons for this, namely trying to true up your income and expenses for a specific period of time, but tell that to the business owner who doesn't know to look for the "asset buildup" of inventory on his balance sheet or the cash outlay shown on her Statement of Cash Flows.)
Another example of this is how you show deposits on your P&L. Imagine you got a $50,000 deposit from a new client two months before you started work on his project. Where does this show up on your P&L?
Trick questions - it doesn't show up on your P&L, it will show up as a liability on your balance sheet (crazy I know, but - sigh - that is the way your controller is going to book the money at that point because to her you still have to fulfill on the work promised, hence it's a liability. When you do the work, it will move off your balance sheet and show up as income on your P&L, but not until you start on the project.)
My point is that your P&L is not always an accurate picture of your actual cash on hand. Various sound and good accounting reasons distorts how the average business person interprets what your P&L actually says.
So take the time to get comfortable with what your P&L is and is not actually showing you.
2. You're P&L doesn't show you the anything about the condition of your assets that you use in the business.
So often business owners can get blindsided with a major repair or normal replacement you should have been able to anticipate, but didn't because all you looked at was what your P&L showed you.
3. Your P&L doesn't indicate working capital reserves you have or will need.
4. Your P&L may not tell you that while you made the sale, and had the cost of producing your product or service, you still haven't collected all the money you're owed.
Imagine you show $1 million in sales this month. Good for you. But if you're on an "accrual basis" for your financial records (which most successful companies are) you may have only collected on $700,000 of that money. You P&L (if it's on an accrual basis) reports all sales as they are made, not as they are collected on. (Again, there are good reasons for this, but to have a full picture you have to remember to look at your "accounts receivable" shown on your balance sheet on a regular basis.)
5. It shows your "profit" but you may not have the cash to pay yourself out that profit.
The purpose of this article wasn't to beat up on your little, old P&L, but rather to give you a clear call to action to learn to understand the full story that your combined financial statements of your P&L, balance sheet, and statement of cash flows tell you when you regularly review them.
If you enjoyed the ideas I shared, then I encourage you to download a free copy of my newest book, Build a Business, Not a Job. Click here for full details and to get your complimentary copy.