Where is my profit, it is not in the bank

This is a question we are regularly asked by clients. Usually, the conversation is triggered when we discuss the end of year accounts.

Before we explain why profits are not always represented by cash in the bank, we need to define the term “profits”. Profits are the difference between what you sell and the costs associated with making those sales.

Consider Jeremy, who runs a small shop selling clothing. He started his businesses by introducing £5,000 of his own money and at the end of his first trading year his summarized results were as follows:

  • Sales £100,000
  • Goods purchased and sold in the year £60,000
  • Other costs paid for in the year £15,000
  • Stock at end of year valued at cost £7,000
  • Drawings for personal use £16,000
  • Bank balance £7,000

His accounts show profits of £25,000 (This is made up of sales of £100,000, less cost of goods sold of £60,000 and less other costs £15,000).

So why, Jeremy asks, is there only £7,000 in his bank account?

The answer is that at the end of the year Jeremy had withdrawn £16,000 for his own private use and he had purchased £7,000 of stock that was unsold at the end of the year. We also need to consider that Jeremy introduced £5,000 of his own cash when the business started.

The reconciliation of his profit and the bank balance is therefore: Profit for the year £25,000, less personal drawings £16,000, less stock £7,000, plus own capital introduced £5,000, equals £7,000 – his business bank balance.

We can deduce from this explanation that to reconcile profit and cash flow you need to factor in receipts and payments that are not considered when calculating profit. In Jeremy’s case: his capital introduced, stock at the end of the year, and his personal drawings.

Latest Blog
20
May

UK Interest Rates Trending Down – What It Means for You

After a period of rising interest rates, there’s a noticeable shift in the UK f...

Read More
15
May

Will you be affected by Making Tax Digital?

Making Tax Digital for Income Tax: One Year to Go The UK tax landscape is on the cusp...

Read More
14
May

What are CDC pensions?

The UK government is introducing a significant shift in pension schemes with the expa...

Read More
08
May

Regulatory Changes Impacting UK Small Businesses

Alongside tax reforms, HMRC’s Spring 2025 update introduces a variety of regula...

Read More