Why a business can be profitable and still short of cash

“The accountant says we made money this year. So why is there nothing in the account?” It is one of the most common questions a small business owner asks, and the answer is not that someone is wrong. Profit and cash are two different measurements, and the gap between them has a short list of causes.

Profit is about when work happens; cash is about when money moves

A profit and loss statement records revenue when the work is done or invoiced, and records costs against the period they belong to. The bank account only moves when money actually changes hands. Those two moments can be weeks or months apart, and that gap is where “profitable but broke” lives.

The usual suspects

Customers who have not paid yet. The invoice counts as revenue the day it is sent. The cash arrives when the customer pays, which for some customers is sixty days later and for some is never without a reminder. The money is real, but it is sitting in someone else’s account.

Materials and stock bought ahead of the work. Paying for materials in March for a job that invoices in May takes cash out now and recognises the cost later.

Loan repayments. Only the interest on a loan is an expense. The principal repayment is not; it reduces a debt on the balance sheet and never appears on the profit and loss statement. A business paying down a vehicle loan or a line of credit can show a solid profit while the repayments quietly consume the cash.

Equipment and vehicles. A truck bought outright is an asset, not an expense. Its cost reaches the profit and loss statement gradually, as depreciation, over years. The cash left on the day it was bought.

Owner draws. Money the owner takes out of the business is not an expense of the business. It does not reduce profit. It very much reduces cash.

Tax payments. Income tax on last year’s profit, and estimated payments on this year’s, are paid out of this year’s cash.

Growth itself. A growing business is constantly funding more work in progress and more unpaid invoices than it was a month ago. Growth consumes cash before it returns it.

How to see it coming

• Read the balance sheet alongside the profit and loss statement. Receivables, loans and equipment all live there. The profit and loss statement will never show you these movements because they are not what it measures.
• Watch receivables. How much is owed to the business, and how old is it? A rising number with rising age is the earliest warning most businesses get.
• Know your fixed monthly outgoings, including loan principal and draws. That is the cash the business needs regardless of sales.
• Plan tax payments as a monthly cost, even though they are paid in lumps.
• Separate the business account from personal spending, so the number in the bank actually means something.

The practical point

If profit is healthy and cash is tight, the business usually does not have a pricing problem. It has a timing problem, a collections problem, or a financing problem, and each of those has a specific fix. The first step is seeing which one it is, and that comes from a balance sheet and a receivables list that are kept up to date, not from the profit figure on its own.