One of the most confusing situations some small business owners encounter is seeing a healthy profit in the accounts while having very little money available in the bank.
This can be an unsettling situation, especially when your figures suggest that the business is doing well. If you’re in this position, it’s important to know that profitability doesn’t necessarily mean that there’ll be enough cash available to meet your business needs.
So rather than simply looking at your profit figure, you’ll need to understand why this could be happening.
In this article, I explain why a business can have profit but less cash in the bank.
Key Takeaways
- Profit and cash measure different aspects of your business, so a healthy profit does not always mean you have plenty of cash available.
- Unpaid invoices, stock and work in progress can leave your business with profit but less cash than you might expect.
- Buying assets and repaying loan principal can reduce your bank balance without reducing your reported profit by the same amount.
- A cash-flow forecast can help you anticipate upcoming payments and identify potential cash shortfalls before they become a problem.
- If you have profit but less cash and need support improving your cash position, Surrey Accountancy can help you identify the pressures on your cash flow and put better financial planning in place.
What Is the Difference Between Profit and Cash?
Profit and cash are both important measures of your business’s financial position, but they tell you different things.
Profit is the amount your business has made after taking its income and expenses into account over a particular period.
It is usually recorded when you make a sale or issue an invoice, even if your customer has not paid you yet.
On the other hand, cash is the money your business actually has available in its bank account. With traditional accounting, it’s only recorded when money actually comes into or leaves your bank account.
7 Reasons Why Your Business May Have Profit But Less Cash
There are several reasons why the profit shown in your accounts may be higher than the cash available in your bank account.
Often, it comes down to the timing of when income and expenses are recorded compared with when money actually moves in and out of your business.
Below are some of the main reasons this can happen.
You Have Made Sales But Your Customers Have Not Paid Yet
One of the common reasons you can have profit but less cash is that your customers have not paid you yet.
With traditional accounting, income is generally recorded when you invoice your customer, rather than when the money reaches your bank account.
So, if you have issued £20,000 worth of invoices but your customers have only paid £10,000, the sales can contribute to your profit while only £10,000 has actually come into the bank.
The remaining £10,000 is money your customers owe your business, but it is not cash you can use yet.
You Have Bought Equipment Or Other Assets
Buying equipment, machinery, vehicles or other long-term assets can also create a difference between your profit and your cash.
The money used to buy the asset leaves your bank account, but the purchase is not necessarily treated as an immediate expense in your profit and loss account. Instead, the accounting treatment may spread the cost over the period in which the asset is used.
So, you can spend a significant amount of cash on an asset without seeing the same amount reduce your profit for that period. The FRC’s cash-flow guidance treats purchases of property, plant and equipment as investing cash flows rather than ordinary operating expenses.
You Are Repaying A Loan
Loan repayments are another reason your cash balance can be lower than your profit.
When you repay the principal amount you borrowed, money leaves your bank account, but that repayment is not an operating expense that reduces your profit. It is a financing cash flow.
This means your business can make a profit while using some of that cash to repay money it borrowed previously.
You Have Cash Tied Up In Stock Or Work In Progress
Your business can also have profit but less cash in the bank because money has been spent on stock or work that has not yet been completed.
For example, your business spends £20,000 buying materials for customer orders. That £20,000 has already left your bank account.
But if some of those materials are still in your warehouse or are being used on work that is not finished, that cost has not all been counted as an expense against your profit yet.
So, your cash has gone down, but your profit has not gone down by the same amount. This is because your accounts take into account what stock you still have and what work is still unfinished when calculating your profit.
You Have Taken Money Out Of The Business
Cash can also leave the business for reasons that do not reduce the profit shown in your accounts as an ordinary business expense.
For example, a company may pay dividends to its shareholders, while a sole trader may take drawings from the business.
These payments reduce the cash available to the business, but they are not the same as expenses incurred to generate the business’s profit.
So, if your business has made a profit but you have also taken money out, the bank balance can be considerably lower than the profit figure.
Your Accounts Include Expenses That Do Not Involve A Current Cash Payment
Not every expense that reduces your profit involves money leaving your bank account at the same time.
Take depreciation, for example. If you buy a piece of equipment for your business, you pay for it when you buy it. But your accounts spread that cost over the years you use the equipment.
Each year, depreciation reduces your reported profit, even though you are not making another payment for the depreciation itself.
Some of the Cash in Your Bank May Already Be Owed to HMRC
If you are VAT registered, not all of the money in your business bank account belongs to your business.
When you charge VAT to your customers, that VAT comes into your bank account along with the money they pay you. But you will normally need to pay the VAT you owe to HMRC when your VAT return is due.
So, even if your account balance may look good, some of that cash is already committed to your VAT bill.
What Can You Do When Your Business Has Profit But Less Cash
Once you understand why your profit and cash position can look so different, you can start looking at ways to improve your cash position.
However, the right approach will depend on what is causing the gap. Here are several ways you can improve your cash position and reduce the risk of being caught short:
1. Keep a Cash-Flow Forecast
A cash-flow forecast shows when you expect money to come into and leave your business. Unlike your profit and loss account, it focuses on the timing of actual cash movements.
This helps you see when you may have more cash available and when you could face a shortfall.
So, it’s important to keep your forecast up to date and make sure it reflects when customers are realistically expected to pay, rather than simply when you raise invoices.
2. Improve How Quickly You Get Paid
If customers are taking a long time to pay, you may have to review your payment terms, make sure invoices are sent promptly and have a clear process for following up overdue payments.
Also, ensure that the payment terms agreed on suits your business and allow for possible delays. Doing this will help you manage your cash more effectively.
3. Plan for Payments Before They Are Due
Build payments coming up for VAT, tax, wages, suppliers, loan repayments or other business commitments into your cash-flow forecast.
This would help you set money aside and avoid being caught by a large payment when your cash position is already tight.
4. Be Careful About How You Use Cash
When your business is profitable, it can be tempting to use the available cash to expand, buy equipment, increase stock or take more money out of the business.
But before making a significant commitment, consider what it will do to your cash position and whether you will still have enough available to cover your regular expenses and upcoming payments.
This is particularly important during periods of growth, when a profitable business can still experience cash-flow difficulties.
4. Look at Your Numbers Together
Your profit and loss account can tell you how your business has performed, but it does not show the whole cash picture.
Looking at your profit, cash flow and balance sheet together can help you understand what is happening to the money in your business and make better-informed decisions about spending, growth and future commitments.
The aim is not simply to increase your profit. It is to understand how the money your business makes moves through the business and whether you have enough cash available when you need it.
Also Read
- Why Small Businesses Have Cash Flow Problems
- VAT Registration UK: A Complete Guide for Small Businesses
- Why Is Cash Flow Important?
- How to Get Your Business Financially Ready for Growth?
When You Need More Than a Profit Figure
Your profit figure can tell you how your business has performed over a particular period, but it does not show you when money will come into or leave your business.
That is why it helps to look at your profit alongside your cash flow and balance sheet. These figures can help you understand what is happening with your money, plan for upcoming commitments and make better decisions about your business.
If you want help understanding your figures and what they mean for your business, Surrey Accountancy can help. We work with business owners to make sense of their accounts and use their financial information to support better business decisions.
If your business is profitable but you need help managing your cash position, get in touch with Surrey Accountancy today.
Frequently Asked Questions
Can a Company Be Profitable But Have No Cash?
Yes. A company can report a profit while having little or no cash available because profit can include sales that customers have not yet paid for.
Why Can a Business Be Profitable but Still Run Out of Cash?
This can happen when cash is tied up in unpaid invoices, stock, or other working-capital needs, while bills and other expenses still have to be paid. Rapid growth can also put pressure on cash because businesses often need to fund new sales before receiving payment from customers.
What Does It Mean If Your Profit is Negative?
A negative profit means the business’s costs and expenses are greater than its income for the period, resulting in a loss.
What to Do When Cash Flow is Low?
Start by reviewing when money is coming in and going out, then focus on collecting outstanding invoices and controlling upcoming expenditure. A cash-flow forecast can help you identify potential shortfalls early and plan for upcoming commitments.
How to Increase Cash Flow in Your Business?
You can improve cash flow by getting customers to pay sooner, managing stock carefully and reviewing the timing of payments to suppliers. The aim is to shorten the time between spending money on the business and receiving payment from customers.
