Understanding the difference could save your business.
One of the most confusing aspects of running a small business is understanding why you can be profitable on paper but still struggle to pay the bills. It’s a situation that catches many business owners off guard, and it’s all down to the difference between profit and cash flow.
What’s the Difference?
Profit is an accounting concept. It’s your income minus your expenses over a period. If you invoiced £100,000 and had £70,000 in expenses, you made £30,000 profit. Sounds great, right?
Cash flow is about actual money moving in and out of your bank account. Just because you’ve invoiced £100,000 doesn’t mean you’ve been paid £100,000. And just because you haven’t paid a supplier yet doesn’t mean you haven’t incurred the expense.
This is where the disconnect happens. You can show a healthy profit while your bank account is in the red.
Common Cash Flow Killers
Slow-Paying Customers
You’ve done the work, sent the invoice, but the payment is 60 days away. Your profit and loss shows this as income, but your bank account shows nothing. Meanwhile, you still need to pay your suppliers, your staff, and your own bills.
Stock and Inventory
If you buy products to resell, you might spend £10,000 on stock in January, but not sell it until March. That’s three months where the cash is tied up in inventory.
Capital Purchases
Bought a new van for £20,000? That’s £20,000 out of your bank account immediately, but for accounting purposes, it’s depreciated over several years. The cash impact is instant; the profit impact is gradual.
Tax Bills
Here’s a painful one. You made a profit last year, so you owe tax on it. But you might have already spent that cash on growing your business. Now you have a tax bill to pay with money that’s no longer sitting in the bank.
Drawing Too Much
As a sole trader or small business owner, you might be taking regular drawings based on your profitability. But if your customers haven’t paid you yet, you could be drawing on money you don’t actually have in the bank.
How to Manage Cash Flow
Forecast Regularly
Don’t just look at what’s in your bank today. Project forward at least 13 weeks. When are invoices due? When do you need to pay suppliers? Are there any large expenses coming up?
Invoice Quickly and Follow Up
The sooner you invoice, the sooner you get paid. And don’t be shy about chasing overdue payments. It’s your money, and you need it to run your business.
Consider Payment Terms
Can you negotiate better terms with suppliers? Even an extra 15 days can make a significant difference. On the flip side, could you incentivise customers to pay faster with early payment discounts?
Build a Buffer
Try to maintain a cash reserve for quieter periods or unexpected expenses. Even a month’s worth of operating costs can be a lifesaver.
Use Credit Wisely
Sometimes short-term finance like an overdraft or business credit card can smooth over temporary cash flow bumps. The key word is temporary, don’t use credit to mask deeper problems.
Warning Signs to Watch
Regularly struggling to pay bills on time, relying on your overdraft every month, or constantly juggling which supplier to pay first are all red flags. If you’re experiencing these, it’s time to take a hard look at your cash flow.
Getting Professional Help
Cash flow problems don’t fix themselves, and they’re not a sign of failure – they’re a common challenge that many successful businesses face. An accountant can help you create realistic forecasts, identify where cash is getting stuck, and implement strategies to improve your position.
Remember, revenue is vanity, profit is sanity, but cash flow is king. Understanding and managing your cash flow isn’t just good practice – it’s essential for survival.
