Your accountant tells you your business is profitable.  Brilliant.  Except you have no cash left in it so it doesn’t FEEL like you are profitable.  Here’s why that might be.  

Timing Is Key:

One big reason for the difference between profit and cash flow is timing. 

Imagine you’ve just made a big sale, boosting your profit for the month. However, it might take time for the cash from that sale to actually hit your bank account. Customers might take a while to pay their bills, causing a delay between when the sale is recorded as profit and when you actually receive the cash.  You could recognise the profit when you send the invoice but not get the cash for 30 days.  

On the flip side, you might have expenses that are included on your profit and loss account but haven’t been paid yet, because you are taking advantage of your suppliers’ payment terms.  

Non-Cash Items:

Another reason for the profit-cash gap is the inclusion of non-cash items in your profit figure.  Look at your profit and loss in your accountancy software.  Some of the things included in it are fancy accountancy terms which don’t affect cash. 

Things like depreciation – which is a fancy way of saying the decrease in value of your assets over time – can reduce your profit without affecting your cash flow. It’s purely an accounting adjustment.  Never gets paid out in cash. 

Similarly, changes in the value of your stock or other assets can impact your profit without any actual cash moving in or out.

Investments and Loans:

What you do with your profit can also affect your cash flow. If you decide to reinvest your profits back into the business – maybe by buying new equipment– that can tie up cash in the short term. 

If you’ve taken out loans or finance to fund your business, you’ll need to make regular payments, which can eat into your cash flow.

These transactions don’t impact profit directly, because they are found on your balance sheet, but can have a big impact on your cash position.

What you take out of the business

This is a big one.  Money you draw out of the business as the business owner.  Whether you are a sole trader taking out ‘drawings’ or a limited company owner taking out dividends, neither of these are deductible from your profit.  

So if you draw out all the cash from your business for yourself this won’t affect your profit figure. But it will drain your bank balance. 

Why should you care? 

Let’s go back to the start of this blog.  Your accountant tells you your business is profitable.  Profits = tax bill = cash needed for tax.  

If you take all the cash out but don’t put any aside for tax you will be in a tricky situation.  That’s why it’s critical you keep a close eye on both your profit and your cash flow, so you are planning for tax bills and have the cash to pay them. 

If you need any help with getting your head around this and getting better at managing your cash then get in touch.  Maybe you have never looked at your profit figure before or you have no idea what a balance sheet is?  Just ask us.  This is the stuff we love helping business owners with.

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