Profits are Cash…Sometimes

Ruth King
Contributing Writer
Profitability Revolution Paradigm

One of my first clients was a florist.  She got her financial statements at the end of each month, looked at the bottom line and saw that she had a profit.  She then put the statements in the drawer and forgot about them.  She became puzzled when she could not pay her bills but her statements showed that she was profitable.  The florist was making a mistake that many contractors do…equating profits with cash.

Contracting companies’ books must be set up on an accrual basis which means that you record a sale when you make it; not when the cash is collected.  Likewise, you record an expense when the bill arrives, whether or not you’ve paid it.  If your CPA wants you to pay taxes on a cash basis, that is a discussion between you and your CPA.  However, on an operations basis, you must be on an accrual basis for accounting.

On an accrual basis when you look at the bottom of your financial statement and see a positive number it only means that you earned a profit.  The number at the bottom of the statement does not represent cash. It is simply the dollar amount of the profit that you earned for that period of time.

You must convert that profit into cash.  This means that you have to collect the money for your work, pay your expenses against the job, and then have cash left over.  Most businesses have more than one job per month.  So, your Quick Books program adds all of the revenues from all jobs and subtracts all of the expenses from all jobs (you can also get an individual job cost report). On your balance sheet it shows you the cash you have and the receivables you have as a result of the jobs. You must be aware of and collect the receivables within a period of time so that you can pay your employees and other bills.

If your accounting system is set up on a cash basis you record a sale when you get the money in for that sale. You record an expense when you pay that expense. There are no receivables, no inventory, and no payables. On cash basis accounting systems the profit shown on your income statement is the actual cash profit.  And, typically when a contractor reports financials on a cash basis, when the company is busy and generating revenue, the company shows a loss. When the company has slower, seasonal times, its shows a profit.  This is exactly opposite of what is probably happening with your business.

Contracting businesses may not have many receivables because most of your residential customers pay COD.  Most commercial contracting businesses do have receivables. Whether a contracting company has receivables or not, they do have accounts payable and inventory, whether the  inventory is recorded on their books (you should) or not.

So, if your accounting is NOT set up on an accrual basis, don’t feel too secure when you see a profit shown on your income statement.  Look closely at your accounts receivables and accounts payable to ensure that you collected for and have the money to pay the expenses for the work you did.

 

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