Profit and cash are not the same thing.

Even if you aren’t a numbers person, as a business owner it’s important that you understand the differences between a profit and loss statement* and a cash flow statement.

For starters, profit and cash are not the same thing. Even the most profitable business will fail if it’s short on cash, which surprises a lot of people.

*Also referred to as a P&L or income statement.

I’ll explain…

Believe it or not, a company can be profitable and still go out of business. How? By running short on cash (also known as a cash crunch).

Here’s a simple example. If you’re buying supplies in January and your customers don’t pay you until June, you’ve got a cash flow problem. That’s not good.

So understanding the difference between cash and profit can mean the difference between success and failure.

Since I want you to succeed, I’m going to explain the similarities and differences between P&Ls and cash flow projections as well as why they’re both important when it comes to the success of your business.

But first, a slight detour to put your mind at ease.

Sometimes even hedge fund guys avoid the numbers.

I had a client named Daniel who was phobic when it came to his startup’s financial projections.  Not so shocking on its own, plenty of people hate numbers… until I learned that he was a Managing Director for a hedge fund. Yes, really.

So if a hedge fund guy is afraid to tackle his own financials, you definitely shouldn’t feel bad if you feel that way too.

That said, you can’t avoid them forever if you want to build a successful business. Anyway, as an owner don’t you want to be in control and making the decisions? informed decisions?

Yeah, I thought so.

Knowledge is power.

To be clear, I’m not saying you have to do the financial work… I’m saying you have to understand it well enough that you’re able to ask smart questions and make educated decisions. You don’t want to be a yes-man (or woman) because you don’t understand the numbers, do you? Remember, this is your business!

So like Daniel, I’m going to help you understand your financials. If you missed my posts explaining financial vocabulary in easy-to-understand, plain English and financial projections (even if you’re not a numbers person), I recommend starting there.

Oh, and before I forget… by the time we finished his financial projections Daniel not only understood them, he could explain them to investors, bankers — even his accountant.

Spreadsheet show and tell.

Cash flow projections. Profit and loss. Blah blah blah… yawn. But once you understand what these spreadsheets are showing you, they become a lot more interesting.

So, what are they showing you? Let’s begin.

Profit & loss projections forecast your revenues, your expenses and what’s left after paying your expenses. It shows you whether revenues will be greater or less than the cost of providing your products and services.

Cash flow projections show similar information, but it’s based on how much money you anticipate flowing into and out of your company’s bank account – and when. This, in turn, tells you:

• How much cash your business will need to pay its bills and meet day-to-day expenses.
• When that cash will be needed.

The similarities.

P&L and cash flow projections are easy to mix up because at first glance a lot of the information looks the same, especially:

1. Revenues. The total amount you expect to receive from selling your products and services.

2. Cost of Goods Sold. The expenses related to buying or making the products you’re selling or the services you’re providing.

3. Gross Profit. How much money your business expects to make before subtracting operating expenses. (Revenues – Cost of Goods Sold = Gross Profit)

When looking at historical information for an existing company, these three categories will look very different since, for example, some customers pay their bills more quickly than others (more on this later). This kind of detail is difficult for startups to predict, but if yours is an existing business, it should be incorporated into your projections.

The differences.

1. Timing

P&L Statements: Revenues and variable expenses appear based on the invoice date, not when payments are made or received. Fixed expenses are divided evenly across the year.

Cash Flow Statements: Revenues and expenses appear based on when cash actually moves into and out of your bank account.

For example, let’s say that you receive a $1,200 invoice dated March 15 for your annual liability insurance premium and you pay it on April 3.

• On your monthly P&L you’ll divide the $1,200 by 12 so that your insurance expense appears as $100 every month (or divide by 4 for a quarterly P&L so that $300 appears every quarter).
• On your monthly cash flow projections, that entire $1,200 expense will appear on your cash flow statement for the month of April.

Or, let’s say you (i) make a sale on June 15 and (ii) you allow your customers to pay within 30 days of the invoice date. When I’m building financial projections I like to be conservative and assume the worst. So in this case, let’s assume that every customer will take 30 days to pay. In other words…

• In your P&L this payment will appear in your June revenues.
• In your cash flow projections the payment won’t appear until July.

2. Types of Expenses

There are expenses that may take cash out of your business, but aren’t related to your everyday business operations. Loan payments as well as the purchase or sale of capital equipment* are good examples.

For instance, if you sell your company’s delivery van, the money from the sale will flow into your bank account and show up on your cash flow statement. But the van has nothing to do with your operating profit — it’s capital equipment — so it won’t show up on your P&L. It will show up on your balance sheet, though.

3. Depreciation and Taxes

The P&L is where your company’s depreciation and tax liability appear. (For a detailed explanation, I recommend speaking with an accountant.) That said, it’s important to know that both items will impact your P&L, but have no impact on your cash flow projections.

So, which one is more important?

Both profit & loss projections and cash flow projections are important for any new business.

The P&L tells you if you’ve got the pieces in place to become profitable. Among other things, it lets you know if your pricing is on target and your expenses are manageable.

However…

If you only complete one financial spreadsheet, the cash flow projection is it. Why? Because running short on cash can kill even the most profitable business.

If you don’t have enough money in the bank, you can’t pay your bills. And if you can’t pay your bills, you can’t keep your doors open. To learn more about this, be sure to check out my next post on why cash is king.

Last but not least.

Even if you plan to hire professionals (bookkeeper, accountant, CFO), it’s your responsibility to understand everything that affects your business financially. Otherwise, you’ll be missing vital information when making decisions about what helps your bottom line (and what doesn’t).