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Ask a small business owner what is more important, cash flow or profit. In our experiences, most will answer profit. Many times we hear, “why am is my company struggling because I am showing a PROFIT”.
Profit can be deceiving because if the company is keeping records on the accrual method of accounting, their “profit” could be in their accounts receivable. Thus, their business may not have money, or “cash” to meet their financial obligations.
To demonstrate what we mean, if the company uses QuickBooks, change the reporting method to cash basis. Bye, bye profit. Accounts receivable needs to collected at a rate equal to or exceeding monthly expenses, otherwise no profit using the cash method.
Most small businesses are better served being cash basis because the income statement will give them a better sense of company performance. While cash basis does not include accounts payable, a cash basis income statement will show a company owner where they are spending cash, rather than what they have incurred in unpaid bills.
A cash basis income statement will also reveal future issues. For example, if the income statement is showing a negative “profit” (or a loss), one might inquire as to how the business owner is meeting obligations. Typically the owner is pulling funds from other sources like credit cards, lines of credit or home equity (ugh!). This scenario creates a future problem because it demonstrates that the business owner is not cutting expenses inline with revenue. This is a tipoff to a potentially bleak future.
So the answer is, to the small business owner, cash flow is more important and relevant.
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