Where Have All My Profits Gone?

Accounting can be a funny thing, for the untrained eye, profits (or losses) in financial statements, create more confusion than anything else.
Every entrepreneur, knows his bank balance. But they do not have a firm grasp of the meaning of profit. No, it is not bank/cash receipts, less payments. Having a healthy bank balance is great, but without an interpretation of “profits”, from an accounting perspective, that healthy cash balance is at risk.
The Financial Statements;
Accountants prepare financial statements, not the business owner(unless he is an accountant of course).The balance sheet in terms of IFRS regulations have now been replaced by the “Statement of Financial Position. The Income Statement, replaced by “Statement of Comprehensive Income”. These definitions should make it much easier, for the layperson to understand the financial statements.
The Statement of Financial position is exactly what it says. The financial position, of the organization. Where does the organization stand? Does it own assets, does it have cash resources (cash and cash equivalents). Is it indebted? If so, by how much? The combination of these aforementioned factors immediately gives management, the ability to evaluate solvency(gearing) debt to assets. Liquidity can be measured.(current assets less current liabilities).
Statement of Comprehensive Income (Income statement) Accounting compels us to record the bigger picture. Unlike receipts and payments, we record income , even if not received, and expenses, even if not paid. Income on credit, plus cash income is thus a fair reflection of the total income (remember, comprehensive income?) The user of the income statement will need to be acquainted with the complete scenario. So it is clear, that all income recorded will boost “ profits” without an increase in cash, so at that juncture books could show a profit, and cash flow would be low.The beauty of accounting is that the corresponding credit sales, will be recorded under debtors or accounts receivable.
Example: A business sales is R10k, cash. Expenses total R6k and asset purchases total R2k.
Interpretation: (R10-R6k-R2k)=Bank/cash balance=R2k
Profit(R10k-R6k)=Profit R4k
AssetR2k. Is the R2k difference deceptive? No, not at all. Remember, any asset (Property, Accounts receivable, ) can be converted to “cash” by a resale. So if the asset of R2k was sold, it could add another R2k to cash. So the R2k+ R2k bank balance= R4k!. Exactly, that is the understanding with comprehensive income!!
Cash Flow Statement
Due to all this confusion, the Cash flow statement was introduced. It used to be optional, but it is compulsory, precisely due to the confusing nature of profits. The cash flow statement, combines the Statement of financial position with the Statement of Comprehensive Income profits, and clearly shows the flow of “cash” only.
Do not engage reporting accountants that ignore cash flows in financial statements. It in essence explains all of the above. By reading this report, you will know where have all your profits gone!
By Sean Goss