Have you ever wondered why your net profit doesn't match your bank balance?
If you have, you are not the only consultant who has asked this question, and there are several reasons why this occurs.
You see, many consulting firm owners use the one financial metric that they know to make business decisions, and that is their Bank Balance.
But let me tell you a little secret, that is the WRONG way to operate your firm.
Bank Balance accounting will leave you financially stressed and strapped for cash.
In today's episode, I will tell you why your net profit and bank balance will NEVER match.
Bank balance accounting is when you log into your bank account and make financial decisions based on its balance.
Your net profit is what you want to generate each month in business. More on that later.
For some consultants, they wait until tax season to prepare a set of financial statements. Therefore, on a daily basis, they use their bank account balance as their primary decision-making metric.
Then you have those consultants who may have hired a bookkeeper who prepare their monthly financials. At the end of each month, they notice a difference between their profit and their bank balance. Often, their profit is a lot higher than the bank balance.
And they tend to wonder why. Some even think the bookkeeper has done something wrong.
Either way, operating in this manner is NOT suitable for a growing firm. So, let's deep dive into why there is a difference and what to do about it.
Profit & Loss Statement Breakdown
First, let's examine a Profit & Loss Statement. Your Profit & Loss Statement is a combination of your total revenue earned and expenses incurred over a particular period.
To determine your Net Profit, you would subtract your income from your expenses. The results will be a Net Profit or Net Loss.
A Net Profit is a result of earning more money than you spent within that period. Conversely, a Net Loss is spending more money than you earned.
The Problem with A Profit & Loss Statement
The problem with a profit and loss statement is that you can earn revenue in one month but receive the actual cash in another month.
Therefore, no funds hit your bank account in the month in which you earned it.
For example, let's say you earned $70,000 in sales revenue and you incurred $20,000 in expenses. That means your Net Profit is $50,000.
$70,000 - Revenue Earned
(-) $20,000 - Expenses Incurrent
= $50,000 - Net Profit
However, out of the $70,000, only $40,000 was paid. That means in that month, only $30,000 was deposited in your bank account. If you take the $30,000 received minus the $20,000 in expenses, that means your bank balance will be $10,000
$30,000 - Revenue Received
(-) $20,000 - Expenses Incurrent
= $10,000 - Bank Balance
On the other side, let's say you received a bill on May 30th but didn't pay the bill until June 15th. This bill will be classified as an expense on your May Profit and Loss statement, therefore reducing your Net Profit.
However, the money would not leave your bank account until June 15th.
Another reason your Net Profit and bank balance differ is when you purchased fixed assets (such as a motor vehicle, plant & equipment, or office furniture).
Fixed assets are not classed as an expense and will not go on your P&L, but the fixed asset amount will still be deducted from your bank account if the items were paid for in cash.
STAY WITH ME NOW!
Also, if you make or receive any owner's drawings, investments, or loans for your consulting firm, they will not be classed as an expense, and they will not reduce or increase your profit, but they definitely will reduce or increase your bank balance.
How to Fix the Net Profit & Bank Balance Difference?
Your bank balance and net profit will never equal the same. So truthfully, the goal is NOT to have your profit equal your bank balance.
The goal is for your firm to generate a net profit AND increase your bank balance collectively.
Therefore, we can conclude that there will be ways in which money will enter and exit your business that will not appear on your Profit & Loss statement.
Please understand that it is extremely dangerous to operate your growing consulting firm using your bank balance.
As you have now learned, many additional factors must be considered when analyzing the firm financials and making business decisions outside of JUST revenue and expenses.
CEO Next Best Steps
With this in mind, my recommendation is to prepare and maintain monthly financials and a cash flow forecast.
With an accurate cash flow forecast, you will proactively review your revenue, expenses, and bank balance to ensure that they are all moving in the right direction.
With accurate financials, you can understand what occurred so that you can capitalize on your successes and repair your mistakes in the future.
The most successful consulting firm I've worked with has a solid financial management system that encompasses financials, forecasting, planning, and action items. Their financial system covers the next 12-months, but it is broken down into quarterly, monthly, weekly, and sometimes daily periods.
You see your goals as a consulting firm owner is to generate a profit and increase your bank balance at the same time. And that my firm is how you truly SAY YES TO PROFITS!
To begin building a solid financial management system for your firm, download my More Money, More Profit Checklist. This free checklist will kick start your ability to have more money and more profits immediately while building a solid financial foundation!
If you are watching the replay and you have questions or comments, leave those below.
Until next time SAY YES TO PROFITS!