Creative Accounting: Why not all Profits are the same

So far we have determined financial information is really important for business owners to understand, and the Profit your business is making doesn't necessarily translate into money in your bank account.

But let's get back to Profit. What are all those adjustments your accountant does at the end of the year - is it 'creative accounting' or 'fee justification'?

I can confidently say it is neither.

To determine the actual Profit or Loss that your business has made, it is important the income earned matches with expenses incurred. This matching principle is commonly referred to (in accountants speak) as 'accrual accounting'.

Many businesses start with 'cash based accounting'. With this accounting method it's easy to ensure the bank reconciliation is done and all transactions are accounted for but your financial statements are purely a representation of your cash flow but not your actual financial position.

Let's think about income - is this generated when the money hits the bank account or when the sale is invoiced? For some businesses the sale and payment occur at the same time. But for others it could be months apart. A sale made today could take more than 30 days to translate to money in the bank. The decisions you make about your trading terms will impact the amount of cashflow you have in your business. To capture the implications of this, you must record your income when the sale is made rather than when the cash is banked.

Likewise, expenses should be recorded when the expense is incurred (i.e. when an invoice is issued to you) not when you pay the bill. Expenses should be recorded as at the date of the invoice.

These two simple changes to your bookkeeping system will allow you to get much greater insight into your cashflow and how to create better cashflow in your business. They will also provide you with a more accurate picture of your business profit.

Together, this will give you the ability to make informed decisions in your business and create a financial strategy that will put you back in control.