Cash Flow vs Profit: Why Profitable Businesses Run Short of Cash

Cash Flow vs Profit

"But we made a profit this month. Why is the bank balance so low?" It is one of the most common puzzles for new business owners, and it has a simple explanation: profit and cash are measuring two different things.

This post explains the difference in plain language, shows a small example with made-up numbers, and lists the usual reasons the two drift apart.

Two different questions

  • Profit asks: "Over this period, did the work I did earn more than it cost?"
  • Cash flow asks: "Over this period, how much money actually moved into and out of my bank account?"

Profit is recorded when work is done and invoiced. Cash moves when someone pays. If those two moments are weeks apart, the numbers can tell very different stories for the same month.

A worked example (fictional numbers)

This example is simplified to show the idea. Real accounts have more moving parts, and an accountant can tell you how yours should be recorded.

A small furniture workshop starts the month with 9,000 in the bank. During the month it completes one job and invoices the customer 10,000, payable in 30 days. To do the job it pays, in the same month:

  • materials: 4,000,
  • wages: 3,000,
  • rent: 1,000.

That is 8,000 of costs.

Month 1

  • Profit view: 10,000 invoiced minus 8,000 of costs = +2,000.
  • Cash view: 0 received minus 8,000 paid = -8,000. The bank balance falls from 9,000 to 1,000.

On paper the workshop had a good month. In the bank, it has spent almost everything it had.

Month 2

The first customer pays their 10,000. The workshop also completes a second, identical job and invoices it for 10,000, again payable in 30 days. Costs are again 8,000.

  • Profit view: 10,000 invoiced minus 8,000 of costs = +2,000 again.
  • Cash view: 10,000 received minus 8,000 paid = +2,000. The bank balance rises from 1,000 to 3,000.

The two months together

  • Total profit over two months: 2,000 + 2,000 = 4,000.
  • Change in cash over two months: 3,000 - 9,000 = -6,000.
  • The gap of 10,000 is the second invoice, which has been earned but not yet collected.

The workshop is profitable and its customers are good. It is still carrying a thin cash balance because it keeps paying for each job a month before it is paid for it. If the first customer had paid two weeks late, month 1's low point would have lasted longer, and rent or wages might have been hard to cover.

Common reasons profit and cash drift apart

Customers pay later than you pay your own bills

This is the classic one, shown above. The longer the gap between paying suppliers and being paid, the more cash the business has to carry.

Buying stock or equipment

Buying stock in bulk, or a piece of equipment, moves a large amount of cash out immediately. The accounts may spread the effect of a purchase like that over time, but the bank balance feels it in one go.

Loan repayments

The part of a repayment that reduces what you owe is cash leaving your account, even though it does not appear as a cost in the profit figure.

Owner draws and personal taxes

Money you take out for yourself, or set aside for tax, reduces the cash available to the business whether or not you think of it as an expense.

Seasonal and one-off payments

Annual insurance, quarterly tax, a yearly software plan: these arrive as a single lump that can fall in an otherwise quiet week.

Growth itself

Perhaps surprisingly, growing quickly can strain cash. More jobs mean more materials and wages paid up front, while the matching customer payments are still on their way.

How to keep an eye on it

You do not need complicated software. A short routine does most of the work:

  1. List what you expect to receive, by the week you expect the money to land, not the invoice date.
  2. List what you must pay, by the week it leaves.
  3. Work out the closing balance for each week.
  4. Mark any week that ends below the minimum you are comfortable with.

That is exactly what a rolling forecast does. If you are new to the idea, start with what a 13-week cash flow forecast is. Then decide what "too low" means for you with how to choose a minimum cash buffer.

A note on reading your numbers

A profit figure and a cash figure are both useful. Neither is "the real one". Profit helps you judge whether the business model works over time. Cash tells you whether you can pay what is due next Friday. Looking at both avoids the surprise of a good month with an empty account.

If you would like a ready-made layout

When I built my 13-Week Cash Flow Forecast template for Microsoft Excel, this timing gap was the main thing I wanted it to show. The Inputs tab has six receipt lines and fourteen payment lines for each of the 13 weeks, and you type each amount in the week the cash is expected to move. The Forecast tab then calculates the closing balance and marks each week OK, LOW CASH or SHORTFALL. A Scenarios section lets you try a Base, Optimistic and Conservative view, for example if customers pay a little less than you hope. It uses standard formulas with no macros and is built for Excel (not tested in Google Sheets). A filled-in example file is included.

Take a look at the cash flow forecast template

Disclosure: I make the Excel tools linked here. This is general information, not financial, tax or legal advice.

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