Small business owners must be aware of three measures of profitability — book, tax, and cash. Each has a specific use and value for managing a business.
“Book” accounting refers to a profit-and-loss financial statement prepared using standard accounting principles. These are the statements that public companies release when reporting financial statements for the quarter or year. They are meant to represent a company’s financial position fairly and accurately.
Tax statements start with the book statements, then make adjustments due to various tax laws. Tax laws typically are special exceptions to standard accounting principles that may favor certain events such as investments in new equipment.
Tax accounting statements determine a company’s tax liability.
Cash accounting (cash-flow accounting) measures a company’s ability to run its day-to-day operations. Most small businesses succeed or fail due to cash issues so cash is the most important managerial tool.
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A company can show a book or tax profit, but be in trouble because of a lack of cash. For example, a sale is recorded as revenue when an invoice is issued; however, many customers pay in 30 or 60 days. The seller may have to pay its suppliers before its customer pays that invoice.
Since most small business owners are not accountants, tracking these metrics is one of the most important functions that your accountant can provide.
Ralph Hershberger is executive vice president and board member of SCORE Southern Arizona, a nonprofit group that offers free small-business counseling and mentoring by appointment at several locations. For more information, go to scoretucson.org or send an email to mentoring@scoresouthernaz.org or call 505-3636.