We are sometimes asked why profit is so much different than the bank balance. “How can I have a profit of $10,000 when there is only $5,000 in the bank?” Profit and bank balance are two different concepts in bookkeeping.
Profit refers to the amount of money your business has earned after deducting all expenses. It is calculated by subtracting all expenses (such as salaries, rent, utilities, etc.) from your total revenue (from sales, services, etc.). If your revenue is higher than your expenses, then your business has made a profit. Likewise, if you do not earn enough revenue to cover your expenses then you experience a loss.
Bank balance, on the other hand, refers to the actual amount of money you have in your business bank account at any given time. This includes all the money you have received from customers and all the money you have paid out to suppliers and for other expenses.
It’s important to note that while profit and bank balance are related, they are not the same thing. You can have a positive bank balance but still not have made a profit if your expenses are higher than your revenue (Example: the owner contributes personal money to the business to cover cash shortages – this results in a positive bank balance even though the business had a loss). Similarly, you can have a negative bank balance but still have made a profit (Example: you have earned money that is owed to you but hasn’t been received yet).
There are many other scenarios that explain the difference and a third, less common, financial statement helps to outline this difference – the Cash Flow Statement.