Keeping track of the financial activities that go on within a business is something every successful business owner has to do. While you may have accountants who take care of this, you still need to know how to read and understand various types of financial statements regarding your business. Two of the most reviewed financial documents are cash flow statements and profit and loss statements. At first glance, these documents appear to be similar, but they have several important differences.
A cash flow statement is used to show business owners all of their financial activities. This means you will able to see the payments you receive as well as business expenses to determine where your money is going. You will also be able to determine approximately how much cash your business maintains on a day-to-day basis. Cash flow statements are important for business owners to understand, because they show every detail with regard to the incoming and outgoing cash of the business. This is also where cash flow statements differ from profit and loss statements.
The purpose of profit and loss statements is to show business owners what their overall profits are over a specific period. A profit and loss statement shows you what your sources of income are versus your expenses. The main difference between a profit and loss statement and a cash flow statement is that your profit and loss statement doesn’t show every detail of your financial activities. For example, profit and loss statements don’t show things such as loan payments, credit card payments and owner’s draws. While you consider these items to be expenses, they aren’t considered expenses for accounting purposes. Therefore, they aren’t recorded as such on the profit and loss statement, but they are recorded on the cash flow statement.
If you want to get a quick picture of your business finances and how much cash you have coming in, you should look at the latest cash flow statement instead of the profit and loss statement. Cash flow statements should be updated on a regular basis, generally each week. This way, you will be able to determine whether you have enough cash coming in to pay your outstanding invoices, because it is possible to make a profit but not have good cash flow, which is why these statements are so important.
To get a clear picture of where your business has stood financially over the past several months, or even years, you need to consult your profit and loss statements. These documents make it easy to compare the profit and loss margins for specific long-term time frames. Profit and loss statements also help you evaluate your current financial picture as well as project your future overall financial picture. Basically, profit and loss statements are effective long-term financial references, whereas cash flow statements are better suited to short-term usage.