Why Does My Business Look Profitable but My Bank Balance Says Otherwise?

The Common Disconnect Between Profit and Cash Flow

Many business owners experience a frustrating paradox: their financial statements show a healthy profit, yet their bank account tells a different story. Despite reporting strong earnings, they struggle to pay bills, cover payroll, or invest in growth. This discrepancy often stems from a misunderstanding of the crucial difference between profit and cash flow.

While profit reflects a company’s financial success over a specific period, cash flow represents the actual movement of money in and out of the business. Understanding this distinction, identifying cash flow pitfalls, and implementing smart cash flow management strategies can help businesses maintain financial stability.

Why Profits Don't Always Mean Cash in the Bank

At first glance, profit and cash flow may seem synonymous, but they measure different financial aspects:

• Profit (Net Income): The amount left after deducting all expenses from revenue. It indicates business performance but doesn’t necessarily mean the company has cash on hand.
• Cash Flow: The actual movement of money in and out of the business, reflecting liquidity and the ability to meet financial obligations.

Common Reasons for the Discrepancy

• Accrual Accounting – Businesses using this method record income when earned and expenses when incurred, rather than when cash is received or spent. This can create a timing mismatch.
• Depreciation and Amortisation – These non-cash expenses reduce taxable profit but do not affect cash reserves.
• Accounts Receivable Delays – Sales may be recorded as revenue before customers make payments, creating a gap between profit and available cash.
• Stock – Cash spent on stock does not count as an expense until the stock is sold, tying up cash.
• Loan Repayments – Debt repayments impact cash flow but do not appear on profit and loss statements.
• Tax Obligations – Profits may indicate a tax liability that hasn’t yet been paid, reducing future cash availability.

Where Your Cash Might Be Tied Up

Understanding where your cash is being held up can help you pinpoint cash flow challenges.

1. Late Customer Payments

If customers take too long to pay invoices, your business might show profits on paper while struggling with cash shortages.

Example: A consultancy firm invoices clients with 60-day payment terms but needs to pay its employees monthly. The delay in receiving payments creates a shortfall despite strong profits.

2. Excessive Stock

Holding too much stock ties up cash that could be used elsewhere.

Example: A retailer overestimates seasonal demand and over-purchases stock. The unsold stock means cash is locked up, restricting the company’s ability to cover other expenses.

3. Large Tax Liabilities

If a business does not set aside enough funds for tax payments, it can face unexpected cash flow problems when payments are due.

Example: A company reports high profits but has not accounted for upcoming tax obligations. When the tax bill arrives, it struggles to make the payment.

4. Overinvestment in Growth

Expanding too quickly without proper cash flow planning can deplete reserves.

Example: A small manufacturer invests in expensive new machinery without forecasting cash flow, leaving insufficient funds to pay suppliers.

Cash Flow Improvement Strategies

To ensure strong cash flow management, businesses must implement proactive strategies.

1. Cash Flow Forecasting

Accurate forecasting allows businesses to anticipate cash shortages and plan accordingly.

Steps to Improve Cash Flow Forecasting:

• Review past cash flow trends to predict future movements.
• Monitor income and expenses regularly.
• Adjust spending based on upcoming cash flow needs.

2. Strengthening Credit Control

Efficient credit control ensures that customers pay invoices on time, reducing the risk of cash shortages.

Best Practices:

• Set clear payment terms and enforce them.
• Offer early payment discounts to encourage prompt payments.
• Send automated reminders for outstanding invoices.

3. Managing Stock Efficiently

Optimising stock levels can free up cash for other business needs.

Strategies:

• Use just-in-time (JIT) stock management to reduce holding costs.
• Analyse sales data to prevent over-purchasing stock.

4. Controlling Expenses and Outflows

Reducing unnecessary expenses can improve cash flow without affecting operations.

Ways to Reduce Cash Outflow:

• Renegotiate supplier payment terms.
• Cut non-essential costs.
• Lease instead of purchasing expensive assets outright.

5. Securing Additional Financing

If cash flow issues persist, securing financing options can provide relief.

Financing Options:

• Business overdrafts for short-term cash gaps.
• Invoice financing to access funds tied up in unpaid invoices.
• Business loans for expansion without depleting cash reserves.

Take Control of Your Cash Flow

While profit is essential, business cash flow is the true lifeblood of any company. Without proper cash flow management, even profitable businesses can face financial strain. By implementing strategic forecasting, improving credit control, managing stock, and controlling expenses, businesses can maintain healthy liquidity and financial stability.

If your business is struggling with cash flow issues, we can help. Contact Wright Vigar today for expert financial advice and tailored cash flow management strategies.