All entrepreneurs need to understand that the Income you made is not necessarily the same as the Cash you have.
Previously, we referenced the differences in the Income and Cash Flow Projections and someone wanted to know what is the difference between the two.
Income in this case is referring to Net Income (NI) and not Gross Income (GI). Gross Income is what you have before you pay your suppliers and expenses so that money doesn’t all belong to you. On the other hand, Net Income is what is left back after you pay your suppliers and expenses so that money DOES belong to you.
But that sounds just like Cash – both seem to be money coming in and going out; so why are they different?
The main reasons why they may be different are noncash and credit transactions.
Non-cash transactions are those which are included in the Income Statement but don’t actually include any movement of cash. The most common example of this is depreciation expense – the loss in value of your assets from wear and tear on equipment as you use or from aging.
Credit transactions are those where the exchange of cash comes at a later date from the exchange of goods and services. E.g. – you sell a product today and allow the customer to take possession of it today although you won’t be paid today. Accounting principles require recognition of the revenue/gross income today but since you were not paid nothing has happened to your bank or cash balance. A similar thing occurs when you buy something “on credit” (as we call it) but won’t have to pay for it until later. While not as common, there are also prepaid transactions where you pay in advance for a good or service which will not be included in your revenue although the money has left your business.
Although credit transactions can help you to earn more when your customers don’t have enough money to pay you immediately as a new business you have to be careful managing credit transactions. You could end up in a situation where you have a lot of money owing so you cannot replenish your stock to make more sales.
Have you ever ran into cash-flow problems because of credit sales? If so how did you fix it?
