Why Have I Made a Profit But Have No Cash?

“My accounts say I’ve made a good profit – so where has all the money gone?”

It’s a question we regularly get asked when we sit down with clients to review their monthly management accounts.

A business might have made a £50,000 profit, but when the owner looks at the bank account, there certainly isn’t another £50,000 sitting there.

Sometimes there’s hardly any additional cash at all.

How can that be?

The answer is that profit and cash are two completely different things.

Understanding the difference is one of the most important financial concepts for any business owner.

Profit Doesn’t Mean Money in the Bank

Your profit and loss account measures the financial performance of your business over a period.

Broadly, it takes your income and deducts the expenses relating to earning that income.

But your bank account measures something different.

It records cash actually coming into and leaving the business.

Some transactions affect your profit but don’t immediately affect your cash.

Other transactions affect your cash but don’t immediately affect your profit.

That’s why the two figures rarely match.

You’ve Made the Sale – But Have You Been Paid?

This is one of the easiest examples.

Suppose you invoice a customer £20,000 in March.

That £20,000 may be included in your March sales and therefore contribute towards your March profit.

But perhaps your customer has 30 or 60-day payment terms.

At the end of March, you’ve made the sale – but you haven’t received the cash.

Your accounts could therefore show a healthy profit while your bank balance remains under pressure.

And the longer customers take to pay you, the bigger the potential difference becomes.

This is why debtor days and credit control are so important.

A profitable business can still run into serious cash-flow problems if it doesn’t collect its debts quickly enough.

Buying Assets Can Use Cash Without Reducing Profit by the Same Amount

Another common reason is capital expenditure.

Imagine your business makes a £10,000 profit during the month.

But during that same month, you buy a piece of equipment for £20,000 in cash.

Your bank account has gone down by £20,000.

But you don’t normally put the entire £20,000 cost of that asset through the profit and loss account immediately.

Instead, the asset appears on the balance sheet and its accounting cost is generally spread over its useful economic life through depreciation.

So you could quite legitimately report a profit while simultaneously seeing a substantial reduction in your cash.

Loan Repayments Can Also Create a Difference

Debt repayments are another example.

If your business repays £5,000 of a bank loan, £5,000 has left your bank account.

But the capital element of that repayment isn’t an expense in your profit and loss account.

You’re reducing a liability on your balance sheet.

The interest element will generally affect profit, but repayment of the original borrowing doesn’t.

Again:

Cash has gone out, but it hasn’t reduced profit by the same amount.

Stock Can Absorb Your Cash

Stock is another major area – particularly for retailers, wholesalers and hospitality businesses.

You may spend substantial amounts buying stock that you haven’t yet sold.

The cash has left your bank account.

But because you still own that stock, its cost isn’t necessarily all reflected as an expense in your profit and loss account at that point.

As a business grows, increasing stock levels can therefore absorb significant amounts of cash.

The company can become more profitable while simultaneously requiring more working capital to fund that growth.

Corporation Tax Doesn’t Disappear Either

Your reported profit can also ultimately create a Corporation Tax liability.

That tax may not leave the bank account until months after the profit was earned.

This is another reason why simply looking at the current bank balance and assuming the money is available to spend can be dangerous.

Some of that cash may effectively already be spoken for.

Growth Can Actually Make Cash Flow Worse

This catches a lot of business owners by surprise.

A rapidly growing, profitable business can experience serious cash-flow pressure.

Imagine sales are increasing quickly.

That’s great.

But perhaps you’re having to:

• Buy more stock

• Employ more people

• Pay suppliers

• Invest in equipment

• Fund larger projects

while waiting 30, 60 or even 90 days for customers to pay you.

The faster you grow, the more cash you may need to fund that gap.

That’s why profitable businesses can – and sometimes do – run out of cash.

So Where Did My Profit Go?

This is where good management accounts become particularly useful.

When we review a client’s monthly numbers, I don’t think it’s enough simply to say:

“You made £30,000 profit this month.”

The obvious next question is:

“What happened to the cash?”

A cash flow statement can help reconcile the movement between profit and cash.

It can show whether cash has been absorbed by things such as:

• Increasing debtors

• Increasing stock

• Purchasing fixed assets

• Repaying loans

• Paying tax

• Changes in amounts owed to suppliers

• Other movements in working capital

Suddenly, the difference between your profit and your bank balance starts to make sense.

Your Accountant Should Explain the Difference

Management accounts shouldn’t simply be a collection of reports emailed to a business owner every month.

They need to be understood.

If your business has made a healthy profit but your cash balance has fallen, your accountant or finance team should be able to explain why.

Perhaps customers aren’t paying quickly enough.

Perhaps you’ve invested heavily in equipment.

Perhaps stock has increased.

Perhaps you’ve repaid borrowing.

Whatever the reason, you should be able to reconcile the movement.

That information can then help you make better decisions.

Profit and Cash Are Both Important

None of this means profit isn’t important.

Of course it is.

Over the long term, a business needs to generate sufficient profit to survive and provide a return to its owners.

But profit without cash can still create serious problems.

That’s why I believe business owners should understand both their profit and loss account and their cash flow.

They’re telling you different things about the same business.

The Bottom Line

If your accounts show you’ve made a substantial profit but you can’t see that money in the bank, it doesn’t necessarily mean something is wrong.

Your profit may be sitting in unpaid customer invoices.

It may have been invested in stock or equipment.

It may have been used to repay borrowing.

Or it may have gone towards any number of other balance-sheet movements.

A good cash flow statement should help explain exactly what’s happened.

So don’t just ask:

“How much profit did we make?”

Ask:

“Where did the cash go?”

Understanding the answer to both questions gives you a much clearer picture of how your business is actually performing.