Module 1 of 1 · 75 minutes
Profit, position and cash, and how they differ
By the end of this module you will be able to
- Explain every major line of a profit and loss account
- Interpret a balance sheet, including what it omits
- Explain the difference between profit and cash
- Identify the accruals that move profit between periods
Amara My accountant says we had a good year. My bank account disagrees loudly. Which one is lying?
Nadia Neither, and that sentence is the reason this module exists. Profit and cash answer different questions, and a business can be excellent at one while dying of the other.
Amara Explain how that is possible.
Nadia You record a sale when you make it, not when you are paid. So if you sold well in March on ninety day terms, March looks superb. The money arrives in June, and meanwhile you have paid your supplier, your staff and your rent.
Amara So growth makes it worse.
Nadia Growth makes it much worse, which is deeply counterintuitive. To sell more you buy more stock and you carry more unpaid invoices, and both are funded before a single customer pays you. The fastest growing business in a sector is often the one closest to running out of money.
Amara Right. Take me to the profit and loss account. What do I look at first?
Nadia Gross margin, not the bottom line. Gross margin tells you whether the thing you sell makes money before the cost of existing. If that is falling, no amount of overhead cutting saves you, because the problem is in the price or in what it costs to deliver.
Amara And the balance sheet? It always balances, so what is it telling me?
Nadia Rather less than people assume. It balances by construction, so the balancing is not evidence of anything. And it is a record of transactions rather than a valuation.
Amara Meaning what, in practice?
Nadia Meaning your staff appear nowhere. Your reputation appears nowhere unless you bought somebody else's. Your building may be sitting at what it cost in 1994. People read a balance sheet as what a business is worth, and it is not that at all.
Amara So what is it good for?
Nadia Structure. What you owe against what you own, how much falls due within the year, and how much of the business is funded by borrowing rather than by owners. Those are real and they are what a lender reads first.
The written material
The profit and loss account
Revenue at the top, then the cost of the things you sold, giving gross profit. Then the costs of being in business at all, giving operating profit. Then interest and tax, giving the profit that belongs to the owners.
The structure matters because each level answers a different question. A falling gross margin is a pricing or a supplier problem. A healthy gross margin with a poor operating profit is an overhead problem. The two have entirely different solutions and the single bottom line hides which one you have.
The balance sheet, and what it leaves out
A balance sheet is a photograph taken at one instant: assets on one side, liabilities and capital on the other, balancing by construction because it is the accounting equation in a suit.
What it leaves out is often what matters most. The workforce is not an asset. A brand built over thirty years usually appears at nothing unless it was bought from somebody. Property may sit at what it cost in 1994. A balance sheet is a record of transactions, not a valuation of a business.
Why profit is not cash
Accounting matches income and costs to the period they relate to, not the period the money moved. A sale made in March is March's revenue even if the customer pays in June. Rent paid annually in advance is spread across the months it covers.
That matching is what makes the profit figure meaningful, and it is exactly what makes it useless as a measure of survival. Growth consumes cash: more sales means more stock bought and more invoices outstanding, both funded before any customer pays.
Knowledge check
The knowledge check and your certificate need a free account, so that your progress and results can be saved as evidence.
The learning itself stays free and open. You are reading all of it right now without an account.