The difference between cash and profit in your business
- Red You can make a profit, but still have less cash than you started with
- Amber Buying a fixed asset will not in itself damage your profitability
- Green Asset financing that truck will also protect your cash position
Why it makes sense to asset finance a vehicle purchase even if cash is available in your business.
I made a loss because I bought new equipment, why doesn’t that show in my accounts?
The short answer here is that the asset purchase does show in your accounts but you need to look in your Balance Sheet as the purchase will not affect your profit and loss account.
The asset purchase does not actually affect the net value of your business, it merely enhances one part of your Balance Sheet and diminishes another part.
Your Balance Sheet explained
You buy a truck for £50,000 and this improves your fixed assets by £50,000. But that had to be paid for I hear you ask? Ahead of the purchase you had £40k cash, so to pay for the vehicle you used £20k of the cash and raised asset finance, e.g. hire purchase, of a further £30k.
To summarise the Balance Sheet movements:
On the plus side your fixed assets + £50k vehicle
On the minus side, your current assets (£20k cash) and your liabilities + (£30k HP) = (£50k)
This leaves your Balance Sheet . . . balanced!
Why don’t I see the truck purchase in my profit and loss as well?
I understand the confusion but to try to clarify, remember that while cash has gone out of the business, it has been replaced by something different which is still in the business, so your business has not been diminished in any way. Using the example above, the £20k cash has been spent, but you now have a truck worth £50k - and HP of £30k – so your business has the same overall worth as it did before the transaction. Looking at it this way, it wouldn’t make sense to show it as a loss.
The difference between cash and profit
Remember that you can make a profit but still have less cash in the business. To give an example: let’s say that you provide £100k of services v £50k cost but you have to pay your costs now, whilst waiting 30 days for the £100k to be paid by your customers.
On your Balance Sheet your cash is - £50k and your Debtors figure is + £100k, a net increase of £50k.
Therefore, whilst you have made a profit of £50k - which is rightly reflected in your Balance Sheet - your cash has actually reduced by £50k.
And remember that you have to be able to carry on trading while waiting for this money, which is why many would say that cash is more important than profit, at least in the short term. This is why, for a lot of businesses, it often makes sense to use e.g. asset finance to fund vehicle purchases even if cash is available in the business. It’s simply protecting the long term and the same could be said about invoice discounting by the way.
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