Nashwa runs a small catering business. Her accountant tells her she made $18,000 profit last year. She looks at her bank account, which has less money in it than a year ago, and asks the question every small business owner asks at some point: if I made a profit, where is it?
Profit is what the business earned on paper. Cash flow is the money that actually came in and went out of the bank. They differ because of timing and because some payments are not expenses: customers paying late, stock bought before it is sold, equipment purchases, loan repayments and money the owner takes out. A business can be profitable and still run out of cash.
Six reasons profit and cash go separate ways
1. Customers have not paid you yet
Profit counts a sale when you make it. Cash only arrives when the customer pays. If you give 30 or 60 days’ credit, and your sales are growing, more and more of your profit is sitting in customers’ pockets instead of yours.
2. Money is tied up in stock
Stock you have bought but not yet sold is not an expense. Its cost only enters profit when it is sold. But the cash left your account the day you paid the supplier.
3. You bought equipment
A new oven, van or computer is paid for in full, in cash, now. In the profit figures it appears only as depreciation, a small part of the cost spread over its useful life. In the year you buy it, cash falls far more than profit does.
4. Depreciation reduces profit, not cash
The reverse also happens. Depreciation lowers your profit every year, but no money leaves the bank for it. So it works in your favour on the cash side.
5. Repayments and drawings are not expenses
Repaying the amount you borrowed, and money you take out for yourself, never appear as expenses in the profit figures. But both come straight out of the bank. For many owners, drawings are the single biggest reason profit never seems to reach the bank.
6. Suppliers give you time to pay
This one helps you. If your suppliers let you pay in 30 days, the cost is in this month’s profit but the cash leaves next month. More supplier credit means more cash in hand.
A worked example: where did the profit go?
Here is how Nashwa’s $18,000 profit turned into a $2,000 fall in her bank balance. Accountants call this a profit-to-cash reconciliation. It is the most useful table a small business owner can learn to read.
| $ | |
|---|---|
| Profit for the year | 18,000 |
| Add back depreciation (no cash left the bank) | 3,000 |
| Customers now owe her more than a year ago | (6,000) |
| More money tied up in stock | (4,000) |
| She now owes suppliers more than a year ago | 2,000 |
| Bought a new van for deliveries | (9,000) |
| Money she took out for herself | (6,000) |
| Change in her bank balance | (2,000) |
Nothing went missing. Every dollar of profit is accounted for. It went into a van, into stock, into unpaid invoices, and into her own living costs. The business is healthy. Its cash is simply somewhere other than the bank.
This is also why a growing business can be in more danger than a shrinking one. Growth usually means more customers on credit and more stock, and both swallow cash before the profit arrives.
More short lessons on money, saving and small business finance are on the HikmaDaily YouTube channel. Subscribe there to get each new one.
Signs your profit is not turning into cash
- Sales are rising, but you are always short at the end of the month.
- The total customers owe you keeps growing.
- Your storeroom is fuller than it used to be.
- You pay suppliers faster than your customers pay you.
- You take out a fixed amount each month, whatever the business earned.
What to do about it
Start by seeing the gap before it reaches your bank account. How to make a cash flow forecast shows how, step by step, and the free Cash Flow Forecast Calculator builds one for you twelve months ahead.
Then work on the six reasons above: invoice on the day you deliver and chase on the day payment is due, buy stock closer to when you need it, plan equipment purchases for months with room, set your drawings from what the business actually earns, and ask suppliers for longer terms before you need them. And if your margins are thin to begin with, check your prices, because no cash plan can rescue a price that leaves almost nothing.
See your profit and cash side by side
The Small Business Cash & Profit Kit plans twelve months of your business in Excel or Google Sheets. It builds your profit and loss, cash flow and balance sheet for every month, shows your tightest month before it arrives, and explains why your profit and cash differ.
Questions people ask
Can a business be profitable but have no cash?
Yes, and it is common, especially in a growing business. Profit can be tied up in unpaid invoices, stock, equipment and the owner’s drawings, leaving little in the bank.
Can a business have plenty of cash but make a loss?
Yes. Customer deposits, borrowed money, selling an asset or delaying payments to suppliers all bring in cash without creating profit. Cash in the bank is not proof that the business is doing well.
Which matters more, profit or cash flow?
You need both. Profit tells you whether the business is worth running. Cash tells you whether it survives the month. A business without profit fails slowly. A business without cash can fail suddenly, even while profitable.
Is depreciation a cash flow?
No. Depreciation spreads the cost of an asset over its life in the profit figures, but no cash moves when it is charged. The cash moved when the asset was bought.
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