Profit without cash: why a business makes money and still runs out of it

The best month and an empty till

James Walker distributes cleaning products to hotels, offices and restaurants. September was his best month: he sold 12,000 and his income statement shows a profit of 2,500. James celebrates on Monday. On Wednesday he checks the bank to pay Friday's payroll, 1,800, and finds 600.

His first thought is that the books are wrong. They are not. James has just run into one of the least intuitive truths in business: you can make money and run out of it at the same time.

Profit and cash are not the same

Accounting records income when it is earned, not when it is collected, and an expense when it is incurred, not when it is paid. That is why the income statement measures whether the business creates value. Cash, on the other hand, moves only when money really comes in or goes out. The two figures drift apart whenever there is a gap between earning and collecting, or between buying and using up.

Five places where money hides

• Accounts receivable: a sale on credit is profit today and cash in 30, 60 or 90 days.
• Inventory: goods bought and still in the warehouse have left the till, but are not yet an expense.
• Loan repayments: interest is an expense; the principal repaid is not, but it leaves the till all the same.
• Equipment purchases: shelving or a vehicle is an asset; it leaves the till in one go and becomes an expense little by little.
• Owner's drawings: they do not reduce profit, but they do reduce cash.

James's month in figures

This is how a profit of 2,500 ended up as 600 in cash, line by line:

The money did not vanish. It is in the hotels' invoices, in the boxes in the warehouse, in the loan that is now a little smaller and in the new shelving. It is just not in the bank, and payroll is paid from the bank.

How to see it in your statements

The income statement tells you how much you earned. The balance sheet tells you where what you earned is. Compare two balance sheets, the one at the start and the one at the end of the month: if receivables or inventory went up, that is where the cash went; if what you owe suppliers went up, they are financing you. That account-by-account comparison is the starting point of the cash flow statement accountants prepare.

Five measures to keep cash flowing

1. Collect sooner. Clear terms on every invoice, a deposit on large orders and a courteous call on the day an invoice falls due.
2. Buy according to what you sell. Stock that does not move is sleeping money.
3. Negotiate terms with your suppliers. If you give customers 60 days and pay suppliers in 15, you finance everyone except yourself.
4. Forecast the coming weeks. A simple table, week by week, with the receipts and payments you expect warns you of the problem before it arrives.
5. Keep a reserve. One month of fixed costs in a separate account turns a crisis into a nuisance.

What James did

That Friday James met payroll with a credit line, at a cost that hurt. The following Monday he changed three things: he asked hotels for a 30% deposit on their orders, negotiated 30 days with his main supplier, and began reviewing every week a table of the receipts and payments for the next eight weeks. In December, another record month, profit and cash finally told the same story.

Where Aconta Online comes in

With every entry up to date, Aconta Online gives you the income statement to know how much you earn, and the balance sheet at any date to see where that money is: with customers, in stock, in equipment or in the bank. The general ledger of each account shows what came in, what went out and what is still to be collected. Aconta does not prepare cash forecasts, but it gives you the true figures to build them on. The first company is free, no card required.