Most business owners look at the profit line and assume the money is in the bank. It usually is not.
Profit is calculated when a sale is recorded, not when the cash arrives. A business can show a strong result for the year and still have far less cash than that result suggests. The difference sits in places the profit and loss statement does not show clearly, unpaid invoices, stock on the shelf, half finished jobs, loan repayments and tax.
This is not a flaw in accounting. It is simply the way profit is measured. But if you run your business by profit alone, you will be surprised by your cash position again and again.
Where the Cash Goes
Think of profit as the starting point and cash as the finishing line. Between the two, several things can absorb money.
Receivables. When customers take longer to pay, you have made the sale and paid the costs, but the cash has not arrived. Every extra day a customer takes to pay is money you are lending them interest free.
Inventory and work in progress. Stock sitting on shelves and jobs that are not yet invoiced both consume cash. In manufacturing, construction and retail, this is often the largest drain.
Capital spending. Equipment, vehicles and fit outs are paid for in cash, but they only reduce profit slowly through depreciation. A business can spend heavily on assets and show little change in profit in the same year.
Loan principal. Interest is an expense and reduces profit. Principal repayments are not. They reduce cash without touching the profit line at all.
Tax and drawings. Tax is paid when it falls due, which may be well after the profit was earned. Owner drawings reduce cash directly.
Each of these is normal. The problem arises when several move in the wrong direction at the same time, and nobody is watching.
Why Growth Makes It Worse
Growth is the usual cause. As sales increase, receivables and stock usually rise with them. A business growing quickly may need a large share of its profit just to fund that extra working capital.
Owners often see revenue climbing and assume the bank balance will follow. It does not. A business can be busier and more profitable and still feel cash poor.
This is why many businesses that look successful end up borrowing more, delaying supplier payments or stretching their own finances to keep going.
The Statement That Shows the Gap
The cash flow statement explains the difference between profit and cash. Most accountants prepare one at year end, but few owners read it.
It starts with profit, adds back non cash items such as depreciation, then adjusts for changes in receivables, stock and payables. It then shows cash spent on equipment and cash raised or repaid through loans.
If you only read one part of your annual accounts, read this one. It tells you where the cash went, which the profit line never will.
Ask your accountant to walk you through the three sections: operating, investing and financing. Most owners find it far more useful than they expected.
What to Do About It
1. Forecast cash, not just profit. A 13 week cash flow forecast is the most practical tool available. Update it every week. It shows you when cash will be tight, weeks before it happens.
2. Track debtor days. Know how long customers take to pay, and watch whether that number is rising. Chase overdue accounts early and be clear about payment terms before you take the job.
3. Set a stock target. Decide how much stock you need to meet demand and hold to it. Review slow moving lines each month and clear them before they tie up more cash.
4. Match loan repayments to cash flow. Ask your lender whether repayment schedules can align with the timing of your income. Many businesses never ask.
5. Set aside tax as you go. A monthly provision stops tax from arriving as an unpleasant surprise.
6. Review the cash flow statement each year. Compare the profit figure with the cash movement. If the gap is widening, find out why before it becomes a problem.
The Bottom Line
Profit tells you whether your business model works. Cash tells you whether your business can keep operating.
You need both. Owners who watch only one of them are managing with half the picture.
Start this month. Build a simple 13 week cash forecast, check your debtor days, and ask your accountant for last year’s cash flow statement. Compare the profit to the cash and ask why they differ.
The answer will tell you more about your business than the profit line ever could.
If you would like help building a cash flow forecast for your business, email me at richard@coumans.com.au, or just call me on 0412 119 232.
Profit is a result. Cash is a discipline. Build the discipline and the result becomes much easier to keep.
