You're making a profit. So why does cash still feel tight?
It’s one of the more frustrating things about running a growing business.
You look at your accounts and see that you’re making a profit. Sales are increasing, work is coming in and, on paper at least, things seem to be going well.
But when you check the bank balance, it doesn’t quite tell the same story.
There’s a VAT bill coming up, payroll is due next week and you’re wondering whether there’s enough money to cover everything comfortably.
So where has all that profit gone?
Profit and cash aren't the same thing
It’s an important distinction, and one that can catch business owners out.
Profit is what remains after you’ve deducted your business expenses from your income. But that doesn’t necessarily mean the money is sitting in your bank account.
Imagine you run a growing service business with monthly sales of around £75,000.
You’ve had a good month. Your accounts show £75,000 of income and £60,000 of costs, leaving a profit of £15,000.
On paper, that’s a positive result.
But £30,000 of your sales invoices are still waiting to be paid.
Meanwhile, you’ve got £25,000 of payroll to cover, supplier payments falling due and a VAT bill approaching.
Suddenly, that £15,000 profit doesn’t feel quite so reassuring.
The business has earned the income, but not all of the money has arrived. And the people and suppliers who keep your business running still need to be paid.
That’s how a profitable business can find itself under pressure to meet its day-to-day commitments.
It doesn’t necessarily mean anything has gone wrong. But it does mean that profit alone isn’t enough to tell you whether the business has the cash it needs.
Growth can make the problem worse
It sounds slightly backwards, doesn’t it?
Surely if your business is growing, there should be more money available?
Not necessarily.
Growth often means spending money before you receive the income that goes with it.
You might need to recruit another member of staff, invest in equipment or software, or bring in additional support to deliver the work you’ve won.
Those costs start immediately. Your customers, meanwhile, might not pay for another 30 or 60 days.
The business can be profitable and growing, but still experience a shortage of cash.
In fact, some of the businesses that need to pay the closest attention to cash flow are those experiencing rapid growth.
There are other demands on your cash
Unpaid invoices are only part of the picture.
There are other reasons why the amount in your bank account might not reflect the profit you’re making.
Tax payments. VAT and Corporation Tax can create significant demands on cash, particularly if money hasn’t been set aside for them.
Loan repayments. The capital element of a loan repayment reduces the money in your bank account, but isn’t an expense in your profit and loss account.
Equipment purchases. Buying equipment outright can use a substantial amount of cash, even though the cost may be spread over several years in your accounts through depreciation.
Money taken out of the business. Director’s loan repayments, dividends and other withdrawals can reduce the bank balance without appearing as ordinary operating expenses.
None of these things necessarily means your business is performing badly.
But they do mean that looking at profit alone won’t give you the full picture.
So what should you be looking at?
I wouldn’t suggest checking your bank balance every morning and hoping for the best.
And I wouldn’t suggest relying solely on your monthly profit and loss report either.
You need to understand how the two fit together.
A few useful questions to ask are:
- How much money are we owed by customers, and when are we expecting to receive it?
- What payments are coming up over the next few weeks?
- Are we putting enough aside for tax liabilities?
- If we take on more work or recruit another person, what will that do to our cash position?
- How much cash does the business need to operate comfortably?
This is where a cash flow forecast becomes particularly useful.
It doesn’t have to be complicated. Even a straightforward forecast for the next 12 weeks can help you spot potential pressure points before they become urgent problems.
It gives you time to decide rather than react when the bank balance gets uncomfortable.
It's about having the full picture
A profitable business isn’t automatically a cash-rich business.
And a business with a healthy bank balance isn’t necessarily making a profit either.
Both numbers matter, but they tell you different things.
When you understand what’s happening to your profit and your cash, you’re in a much better position to make decisions about recruitment, investment, pricing and growth.
You can plan ahead with a little more confidence, rather than wondering whether the money will be there when you need it.
At S J Accountancy, I help owner-led service businesses understand what’s happening behind their numbers, so they can make informed decisions about what comes next.
If you’d value having a finance person in the conversation earlier, let’s have a chat
If your accounts are showing a profit but your bank balance is telling a different story, perhaps it’s time we had a conversation.