Is your profit an illusion?11th July 2018
I have a question for you:
When your accountant says that your business is profitable, are you absolutely certain that they’re right?
Most business owners would say: Yes. My accountant has given me a breakdown of the accounts and an overall number that shows we’re profitable. The bottom line is the bottom line….
But while most business owners might believe this, they aren’t entirely correct.
You see …
Depending on your numbers, it’s entirely possible that a different accountant might arrive at a different figure altogether. It might show that you’re less profitable… More profitable... Or not profitable at all….
And they could both be right.
It can be hard to get your head around, but profit isn’t absolute. It’s a subjective figure.
Let me give you an example…
Let’s say a client hasn’t paid an invoice on time. They keep on promising that the payment is on its way, and they’ve always been good payers in the past. But it’s been a while and so far, there’s no sign of the cash in the bank.
You’ve counted it as a sale (maybe you have even delivered the work or products), but, in reality, you are not sure whether it will ever be paid.
If your accountant is cautious, they may make a bad or doubtful debt provision against this. But another may not.
Both conclusions are acceptable.
But they will result in different statements of your profit.
That’s why, as the business owner, you can’t simply look at that figure and go spend the money.
You need to ask your accountant questions, to understand exactly what decisions they took to arrive at the final profit figure. Whether or not to count doubtful receipts that have not yet materialised as profit is just one of the many considerations on which two accountants may differ!
Without this, you’re in danger of misinterpreting how profitable you really are, and start spending money which is only theoretical.
In fact, it’s a mistake to focus on profit all by itself.
To make an informed decision about how much cash you have to invest in your business, you must understand revenue, profit and cash flow together to get an overall picture of the financial health of your company.
It’s easy to focus on a single figure – profit – but this figure alone can be misleading, for the reasons I’ve just outlined.
Now, I won’t go into detail on how to understand revenue, profit and cash flow right now.
But over the next few blogs from me, we will delve into the best ways to measure your profitability, and how to use this information to make smart decisions for your company.
For now, the important thing to remember is that when your accountant tells you you’re profitable, you must question them to find out exactly how they arrived at that figure, so that you understand what the numbers they present you with actually mean.
That is standard procedure when we work with our clients. So if that’s the kind of insight you’d like into your financials, just get in touch and let’s talk about how we can help you.