How a Net Profit exists with Debt

Q:  How can I show a Net Profit and owe on Credit Cards (and / or Loans)? I had to pay tax on my Net Profit, but I don’t even have that cash in the bank to pay off debt.

A:  Explanation of how you can show a Net Profit, while having debt:

• Taxes don’t have anything to do with how much cash is in the bank or how much debt is owed (whether credit cards or loans).
• The taxable income of a business is the Net Income, which only considers the Sales Income minus the direct cost of those sales, which is Cost of Goods Sold and Indirect Costs, which are overhead and operating expenses, like rent, wages, advertising, etc.
• The business had a profit at the end of the day, and that is taxable.
• But the profit wasn’t enough pay off the loan, while maintaining some cash in the bank, floating while invoices are waiting to be paid and paying existing bills.

It’s called double entry accounting because there are two main reports and all of the account categories used in the business show up on these 2 reports:

1. Income Statement (aka Profit and Loss report)

2. Balance Sheet

On the income statement, you can show Sales Income, while that same income will increase cash in the bank on the Balance Sheet.

Likewise, you can show categorized business expenses on the income statement, while how those expenses were paid is on the Balance sheet, decreasing cash in the bank, or increasing debt on a credit card.

For tax purposes, only the income statement is considered.

Income – Expenses = Taxable Profit or Loss

Another thing to think about is that the income statement is a snapshot of one year, while the Balance Sheet accrues over time. The balance of your bank account doesn’t restart each year from zero, thank goodness, but debt also doesn’t reset. Therefore, it can accumulate and be more than any net profit from the business.

The Net Profit is usually spread out between Cash in the Bank, Debt that paid for those expenses, and draws from the Owner.

Does that clarify how you can have a net income and not see it in your bank account? Please comment below with questions if not!