Profit vs Cash
Profitable businesses run out of money. It happens often enough that it should not surprise anyone, and yet it catches owners out every year, usually in the month they were feeling most pleased with the accounts.
Profit is an opinion shaped by accounting rules. Cash is a fact you can check on your banking app. Understanding the gap between them is one of the highest-value things an owner can learn.
Why the two diverge
Profit is recorded when you raise the invoice. Cash arrives when the customer decides to pay it, which might be sixty days later, or ninety, or after three phone calls. A business growing quickly invoices more, so its profit rises, while the cash for that work sits in someone else's bank account.
Then there are the things that consume cash but never touch the profit and loss. Stock you have bought but not sold. A van bought outright. Loan capital repayments, where only the interest is an expense. VAT and PAYE you have collected on behalf of HMRC and are simply holding. A corporation tax bill for a year that already feels like history.
None of that appears as a cost in your profit figure. All of it takes cash out of the account.
Growth is the usual culprit
This is the cruel part. The faster a business grows, the more cash it consumes. More work means more stock, more wages, more materials, all paid before the customer pays you. An owner who wins a large new contract can be more profitable and closer to insolvency in the same quarter.
A plumbing firm that doubles its work needs to buy twice the parts and pay twice the wages up front, then wait the same sixty days to be paid. The profit and loss looks excellent. The bank account is the tightest it has ever been.
The number that explains it
The cash conversion cycle is the honest measure: how many days pass between money leaving your business and coming back. Debtor days plus stock days, minus creditor days.
If customers take 60 days to pay, stock sits for 30, and you pay suppliers in 30, your cycle is 60 days. Every pound of growth needs funding for two months. Shorten that cycle and the business funds its own growth. Lengthen it and growth has to be borrowed for.
How to apply it
- Look at both numbers every month. Profit and closing cash, side by side. When they move in opposite directions, find out why before it becomes a pattern.
- Work out your cash conversion cycle. Debtor days plus stock days minus creditor days. Know the number, then set a target to cut it.
- Attack debtor days first. It is usually the cheapest win. Invoice the day the work completes, state terms plainly, and chase on a schedule rather than when it occurs to you.
- Ring-fence the tax money. VAT and PAYE are not your money. A separate account removes the single most common cash shock in small business.
- Build a rolling 12-week cash forecast. Not an annual one. Twelve weeks is close enough to be accurate and far enough ahead to act.
- Model the growth before you take it. Before accepting a large contract, work out the cash it consumes before it pays. Some good work is not affordable yet.
The questions to sit with
- Out of 10, how confident are you that you could explain why your profit and your bank balance disagree this month?
- How many days does it take, on average, from paying for something to being paid for it?
- If your best customer paid 30 days later than usual, how long could the business carry that?
- What would change in how you run the business if you watched cash as closely as you watch sales?
This underpins Know Your Numbers and Cashflow Mastery. Most owners do not have a profit problem. They have a timing problem that only shows up as a cash problem, usually too late to fix calmly.
