News & Insights

Many business owners review their financial reports regularly, but two reports are often confused: the Profit & Loss Statement and the Cash Flow Statement. While both deal with money coming into and going out of a business, they serve different purposes and provide different insights as explained below. But first, it is important to understand the difference between the “cash basis” and “accrual basis” methods of accounting. 

Cash basis accounting records income when cash is actually received and expenses when they are actually paid. Accrual basis accounting records income when it is earned and expenses when they are incurred, regardless of when money changes hands. As a result, cash basis accounting focuses on actual cash flow, while accrual basis accounting provides a broader picture of a business’s financial performance by matching revenue and expenses to the period in which they relate, as opposed to when they are received or paid. Small businesses most often use cash basis accounting for simplicity, while larger or more complex businesses commonly use accrual accounting for more accurate financial reporting. But while a “cash basis” P&L does focus more on cash flow, a lot of payments your business makes appear only on the balance sheet, not the P&L, so a business owner cannot rely solely on a P&L to understand how much cash is available for day to day operations.  

A Profit & Loss Statement (P&L) measures the profitability of the business over a period of time. It summarizes revenue earned and expenses paid to show whether the business generated a profit or loss during the month, quarter, or year. For a cash basis business, the P&L reflects the income actually received during the period and the expenses actually paid during the period. The P&L helps answer the question: “Is the business operating profitably?” But, it is a document prepared primarily for tax purposes and is intended to minimize net profit in order to reduce taxes owed. The P&L does not include payments made for the purchase of major fixtures or equipment, or for the principal portion of loan repayments, which appear on the balance sheet instead. So the P&L does not really provide the full picture of how much cash a business has on a day to day basis for operations. A business with a good net income on the P&L might still be cash poor if there are significant capital investments or owner draws that only appear on the balance sheet.     

A Cash Flow Statement, however, focuses on where all cash came from and where it went. It tracks the movement of cash through the business and categorizes it into operating, investing, and financing activities. The cash flow statement typically includes:

• Cash received from customers
• Cash paid for operating expenses
• Loan proceeds and loan repayments
• Equipment purchases
• Owner contributions and distributions

As noted, the cash flow statement includes many transactions that do not appear on the P&L at all. Payments for the purchase of equipment, the principal portion of loan repayments, and owner draws and contributions appear on the cash flow statement but not on the P&L. As a result, a business can show a profit on its P&L while still experiencing cash shortages because cash is being used for debt payments, equipment purchases, or owner distributions. Similarly, a business that appears stable might be receiving an infusion of cash from the owner, or from affiliated commonly owned businesses, or it might be borrowing money while not operating profitably. This is why business owners should review both reports together. The P&L measures operational performance and profitability, while the cash flow statement shows the overall movement and availability of cash. A simple way to think about the difference is this:

• The Profit & Loss Statement shows whether the business made money.
• The Cash Flow Statement shows how cash moved through the business and how much cash remains available for day to day operations.

Understanding both the P&L and the cash flow statement helps business owners make better financial decisions, avoid cash shortages, and plan confidently for future growth. Buyers and sellers of businesses will want to examine both documents for a full picture.  If you need help preparing your business or sale, or help evaluating or completing a business buy/sell transaction, contact RC Kelly Law at 215-896-3846 or rckelly@rckelly.com.    

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