Making Money in Business
A successful business is one that gives the business owner what they want; and what business owners want - their goals, motivations and ambitions - is diverse. We know in the small business community that making money is rarely a primary goal or motivator, but it is a critical component of business success. Without it, the business and the business owner are devoid of the resources they need to achieve their goals. It’s then surprisingly common to find business owners unclear about whether they are making money.
There are different ways to measure whether you are making money in business. Where most small businesses start is by looking at the money they have in the bank. Business owners want and need to know whether they have enough money in the bank to pay the bills next week or month. Once they are confident that they can meet their short term commitments, people tend to start thinking about a longer time horizon. How much money can the business make? When will it start to give them the money that they want?
To answer these questions we need to think about cash, profit and equity - three separate components. Much of the confusion for business owners comes when they treat these things as one. That is understandable! Most business owners start out in business with no background or training in finance. So below, we explain the difference between each and what they tell you about your business and whether it’s making money.
the cash flow
To understand our business cash flow we need to look at more than just the balance on our bank statement at a point in time. Our bank balance is not the whole picture. There may be money that you owe people - taxes, subscriptions, salaries - that hasn’t gone out of the bank yet. There may be money that people owe you - unpaid invoices - that hasn’t been paid into the bank yet. A cash flow takes into account all these things.
The other thing about cash is that it’s possible to have cash in your bank but not be making money - you may be making a loss. Losses happen at some point in the life of almost all businesses. The problematic thing about losses is that you may not realise you are making a loss if you only look at cash.
The profit and loss
To know if your business is making a profit or loss you need to look at your Profit and Loss (P&L) account. The P&L summarises all of the sales and expenditure transactions of a business in a given period. If sales are greater than expenditure in a period we have made a profit, and if they are less a loss. The important thing to know about the P&L is that sales and expenditure transactions are included in the P&L even if no cash has come in or out of the bank account. That’s why it’s possible to be making a profit, but still run out of cash. For example, you might be running a profitable shop but have tied up all your money in stock - then you may not be able to pay your staff and the shop will need to close.
the balance sheet
There is another way to look at whether your business is making money and that is the Balance Sheet. The Balance Sheet is a snapshot at a point in time that shows both the things the business owns (assets) and things the business owes (liabilities). The net of those two things is the businesses’ Total Equity - it represents the accumulation of profit (and loss) after tax that has not been distributed to company directors and shareholders. So, when we make money in business, total equity goes up. When we make a loss, or take money out of the business, total equity goes down.
So, whether we are trying to understand the money our business has made us, or looking forward to estimate what the future might hold, it is important to consider and treat separately the three components of cash, profit and equity.
