Many businesses rely on their P&L to gauge how well their business is doing, but that’s a bad idea. While there’s a place in your business for your P&L statement, it’s not in running your contracting business on a day-to-day basis. Your P&L will lie to you every day of the week because it’ll tell you you’re making money, even if you’re not.
If you really want to know what’s happening in your business, then you need to know the differences between cash flow and accounting. Let’s examine them.
The Two Big Differences
As a business owner, there are two basic differences between cash flow and accounting that you should know.
Difference #1: Depreciation vs. Equipment Replacement Costs
The first major difference is depreciation versus equipment replacement costs, and what that means for your business. Depreciation has to do with accounting. It relates to what you pay for a piece of equipment from one year, two years, even three years ago. Depreciation is exclusively an accounting number that provides information on the reduction in the value of an asset over time since its first purchase. It does not actually have any direct cash impact. Equipment purchase, on the other hand, is tied to cash flow since your business has to spend money in order to get an asset replaced. This purchase has a direct cash impact, whereas depreciation does not.
Difference #2: Loan Payment Numbers
The second major difference is how loan payments are handled. If you have a $500 monthly loan payment and of that $500, $100 is going toward the interest and $400 is going toward principal, what shows up on your P&L statement? It’s not the entire $500; it’s only the $100 in interest. Right there, you’re dramatically under-reporting the expenses in what it costs you to run your business. If the $400 isn’t an expense, it shouldn’t be showing up on your P&L statement.
Making Sense of It All
If you want to know the truth about how your business is doing, you can’t just look at your P&L statement and expect it to be true. You have to know the difference between cash flow and accounting, and run your business accordingly. Accounting and cash flow numbers show up completely different. And while your first instinct may be to assume that there’s a discrepancy, that’s not necessarily the case. Differing values for accounting and cash flow do not automatically mean that one is correct while the other is wrong. It simply means that the two are calculated differently, and knowing this difference can help you analyze your business’s financial performance and the flow of expenses better.
Know How Well Your Business Is Doing!
Ultimately, knowing as much as you can about your business’s finances enables you to make smart decisions so you can grow your contractor business. If you’re asking yourself, “How can I grow my contractor business?”, you can start today by watching our free webinar!