Profitable but No Cash in the Bank? Why Profit and Cash Flow Are Different

It’s one of those questions that can genuinely puzzle a business owner.

The accounts say you’re making a profit. Sales are healthy. Business seems to be going well.

So why does the bank account look decidedly less impressive?

We come across this more often than you might imagine, and the explanation usually starts with one important distinction: profit and cash are not the same thing.

You can run a perfectly profitable business and still find yourself short of cash. In fact, a growing business can sometimes feel more cash-hungry than one that isn’t growing at all.

Profit isn't money sitting in your bank account

When we prepare a set of accounts, the profit figure tells us whether the business earned more than it spent over that period.

But it doesn't tell us where the money is right now.

Imagine you invoice a customer £10,000 in August.

That £10,000 contributes to your sales and, ultimately, your profit. But if the customer doesn't pay you until October, you can't use that £10,000 in August to pay your staff, suppliers or VAT bill.

You've made the sale. You've made the profit. You just haven't got the cash yet.

That's where many cash-flow problems begin.

Your customers may be holding your cash

Take a look at your debtors.

If you have £40,000 sitting in unpaid customer invoices, that's £40,000 you've earned but don't currently have available to spend.

And the longer customers take to pay, the more of your own money you're effectively using to finance them.

This is why we think credit control deserves far more attention than it sometimes gets. Sending an invoice isn't the end of the sales process. Getting paid is.

Clear payment terms, prompt invoicing and following up overdue accounts can make an enormous difference to cash flow without the business having to sell a single pound more.

Growth can consume cash surprisingly quickly

This one catches people out.

Suppose business is booming and you win several large new customers. That's good news, of course, but you may need to buy materials, increase stock, take on another employee or pay subcontractors before those customers pay you.

Suddenly, growth is demanding cash faster than it produces it.

We've seen businesses where the underlying performance is good but the cash position becomes increasingly uncomfortable simply because the business is expanding.

That doesn't necessarily mean something is wrong.

It does mean you need to plan for it.

A cash-flow forecast lets you look ahead and ask a much more practical question than “Are we profitable?”

“Will we actually have enough money in the bank when we need it?”

Stock can hide a lot of money

If your business carries stock, some of your cash may simply be sitting on a shelf.

You bought the stock with cash, but until you sell it and the customer pays you, that money hasn't completed its journey back to your bank account.

That isn't necessarily a problem. You need stock to trade.

But too much stock, slow-moving stock or products that simply aren't selling can quietly absorb a significant amount of working capital.

It's worth looking at stock not just as something the business owns, but as cash that hasn't come back yet.

That change of perspective can be quite revealing.

Then there are VAT and tax

This is another area where the bank balance can give a misleading sense of comfort.

If you're VAT registered, some of the money customers pay you isn't really yours. You're collecting it on behalf of HMRC.

The same principle applies to other tax liabilities. A healthy bank balance today doesn't necessarily mean all of that money is available to spend.

We much prefer businesses to anticipate these bills rather than deal with them as unpleasant surprises.

Knowing roughly what is coming, and setting money aside for it, makes running the business considerably less stressful.

Loan repayments don't always behave the way you expect

Debt repayments can create another difference between profit and cash.

When you repay a loan, part of the payment may relate to interest and part to repaying the capital you originally borrowed.

The cash leaves your bank account either way, but the capital repayment isn't simply treated as an expense in your profit and loss account.

So you can have a profitable month while substantial amounts of cash leave the business to repay borrowing.

Again, nothing mysterious is happening. Profit and cash are simply measuring different things.

And sometimes the money has left through the owners

It's also worth looking at drawings, dividends and directors' loan accounts.

A business may generate healthy profits but still struggle for cash if too much money is regularly taken out.

There's nothing wrong with owners enjoying the rewards of a successful business. That's rather the point.

But those withdrawals need to be sustainable.

The business still needs enough working capital to pay its bills, fund growth and cope when something unexpected happens.

So what should you be watching?

We wouldn't suggest running a business by staring nervously at the bank balance every morning.

The answer is better information.

We want business owners to understand three things together: profitability, the balance sheet and cash flow.

Each tells you something different.

Your profit and loss account tells you how the business is performing.

Your balance sheet helps show where the money has gone.

And your cash-flow forecast helps you see what may happen next.

Put those together and the picture becomes much clearer.

Profit matters. But cash keeps the business moving.

A profitable business with poor cash flow can still find itself under real pressure.

That's why, when someone tells us their business is doing well but they never seem to have any money in the bank, we don't automatically see a contradiction.

We start looking for where the cash has gone.

It may be sitting with customers who haven't paid yet. It may be tied up in stock. The business may be funding rapid growth, repaying borrowing or preparing for tax liabilities.

Once you understand where the money is going, you can start doing something about it.

And that's a much more useful conversation than simply asking whether the business made a profit.

Want a clearer picture of where your cash is going?

If your business is profitable but cash always seems tighter than it should, it may be time to look beyond the profit figure. At Ledgers Accountants, we can help you understand where your money is tied up, what may be putting pressure on your cash flow, and what the numbers are telling you about your business.

Talk to us about your business finances