Your Bank Balance Is Not Your Profit

The number in your checking account is the most-watched figure in most small businesses, and one of the least reliable.

Every owner I've worked with has a moment in the month when they check the balance and decide how the business is doing. Flush on the 12th means things are good. Thin on the 28th means things are tight. It's fast, it's free, and it's right often enough that the habit sticks.

It's also the single most misleading number available to you.

Not because the bank is wrong — the balance is exactly correct. It's misleading because it answers a different question than the one you're asking. The balance tells you how much money is sitting in an account at this instant. It doesn't tell you how much of that money is already spoken for, how much work you've done that hasn't been paid for yet, or whether the business made money this month. Those are three different questions, and the checking account can't answer any of them.

A quarter-hour that changes the picture

Here's a contractor on the 12th of the month with $48,200 in the account. That feels like a good month. Now look at what's already committed:

The account isn't holding $48,200. It's holding negative $1,800 with an optimistic face on it.

Two of those lines deserve a closer look, because they're the ones that catch people. The withheld payroll taxes were never the business's money — that amount came out of employees' pay and is being held until it goes where it's going. It sits in the same account as everything else and looks exactly like the rest of the balance, which is what makes it dangerous. (If you collect sales tax, it belongs on this list for the same reason.) And the $12,000 customer deposit isn't revenue; it's an obligation. The business has been paid to do work it hasn't done yet. If the job were cancelled tomorrow, that money would go back out the door.

Now run it the other direction. Suppose the same contractor has $31,000 in completed work invoiced and unpaid. That's profit that has already been earned and is sitting in someone else's account. The bank balance doesn't know it exists.

So the balance overstates the business in one week and understates it in another. What it never does is tell the truth about profit.

The four things the balance can't see

Timing. Money arriving today and money leaving on the 20th appear in the same number until the 20th. A checking account is a snapshot; a business runs on a calendar.

Money that isn't yours. Payroll taxes withheld, customer deposits, retainers for work not yet performed, sales tax if you collect it — all of it sits in the same account as everything else and looks identical to earnings.

Work you've done but haven't been paid for. Receivables are profit that already happened. The account won't show them until the check clears, which may be sixty days after the work was worth something.

Cash movements that aren't expenses, and expenses that aren't cash. A loan payment reduces your balance, but only the interest portion is a cost of doing business — the principal is just moving a liability off your books. An owner's draw reduces the balance and isn't an expense at all. Meanwhile depreciation on your truck is a real expense that never touches the account. The balance moves for reasons that have nothing to do with profit, and stays still for reasons that do.

What to look at instead

Three things, and none of them takes long once the books are current.

A profit and loss statement for a defined period. Not “how much is in the account,” but “what did this business earn and spend in July.” It's the only number that answers the profitability question, and it's meaningless unless the month is closed and reconciled — which is most of what monthly bookkeeping is for.

An accounts receivable aging report.A list of who owes you what, sorted by how long it's been outstanding. This is the profit you've earned and haven't collected, and it's usually the difference between “we had a bad month” and “we had a fine month and nobody paid us.”

A short forward view of cash. What's committed in the next thirty days against what's expected to arrive. This is the question the bank balance was standing in for all along, and it's a better answer to it.

Profit and cash are genuinely different things, and a business can be profitable and broke at the same time — that's the most common way a growing company gets into trouble. Adding crew and taking bigger jobs means paying for labor and materials months before the money comes back. The P&L looks excellent. The account looks alarming. Both are accurate, and only one of them is a reason to panic.

If your work isn't measured in jobs

The same gap shows up wherever there's a delay between doing work and getting paid for it. A retainer collected in advance isn't revenue until the hours are worked against it. A large invoice sent on the 30th with net-30 terms is sixty days from being cash. If you bill for time, the balance in your account is mostly a report on your clients' payment habits, not on your practice.

Where this leaves you

None of this requires new tools. It requires the books to be current enough that the P&L and the aging report mean something, which is the ordinary rhythm of monthly bookkeeping rather than a special project. If you're behind, that's the place to start — a reconciled month is what makes every other number trustworthy. And once it is current, the same books will tell you which of your jobs are actually carrying the business.

At EMJ Advisors, I keep the monthly close on schedule and put the profit and receivables picture in front of you while it's still current enough to act on. Your CPA gets books that are ready to file. You get to stop reading the tea leaves in your checking account.

If you've been running the business off the bank balance, it's worth one conversation to see what the real numbers say. They're often better than you think — and when they aren't, it's better to know in August than in April.

EMJ Advisors — Bookkeeping Services provides bookkeeping for service businesses utilizing QuickBooks Online, based in Chatham, New Jersey and working with clients nationwide.