Cash flow vs profit: why a profitable business runs out of cash

Profit is what the business earned. Cash flow is when the money actually moves. Your P&L can show a great month while the bank account goes down, because profit counts sales when they're earned and bills when they're owed, not when anyone pays.

That gap is how a profitable business runs out of cash. It's one of the most common problems in a small business, and one of the least understood.

A worked example

Say your P&L shows $15,000 of profit for March. (Made-up numbers.) Here's where the cash actually went:

• Clients owe you $9,000 more at the end of March than they did at the start. You earned it; you don't have it yet.
• You paid $3,000 of loan principal. Principal never shows up on the P&L.
• You took a $6,000 owner's draw. That isn't an expense either.

$15,000 of profit, minus $9,000 still owed to you, minus $3,000 of principal, minus $6,000 of draw.

The bank account went down $3,000 in a month that made $15,000.

Nothing was wrong with the profit. It just wasn't cash.

Six places profit hides from your bank account

1. Money clients owe you. Every dollar of unpaid invoices is profit you can't spend. The faster you grow, the more of it there is.
2. Prepaid work you've already spent. A client pays $3,000 up front for six months. You have the cash in month 1 and the work for months 2 through 6. Spend it in month 1 and you're delivering for five months with nothing coming in from that client. I call this phantom revenue.
3. Loan principal. The interest is on the P&L. The principal isn't, and it comes out of the bank every month.
4. Owner's draws and distributions. They come out of cash, not out of profit.
5. Growth costs paid ahead. A hire who starts before the revenue they'll handle, equipment, a deposit on a bigger space.
6. Taxes. You owe them on profit. They're paid in lumps, often on a different schedule than the profit came in.

The misread

"We're profitable, so cash will sort itself out."

It won't on its own. Profit tells you whether the business model works. Cash flow tells you whether you'll make payroll on the 15th. You need both, and they answer different questions.

How to improve cash flow without changing profit

• Invoice the day the work is done, not at the end of the month.
• Shorten payment terms on new clients. Net 15 instead of net 30.
• Take deposits or milestone payments on large projects.
• Put prepaid money somewhere separate and move it into your operating account as you earn it.
• Match loan payments to the asset's life, not the shortest term the bank offers.
• Set aside tax money every month, in its own account, so the quarterly payment isn't a surprise.

None of those changes your profit. Every one of them changes when you have the cash.

See it coming

The tool for this is a 13-week cash flow forecast. It shows the week cash gets tight, while there's still time to do something.

Run your own numbers

If the business is profitable and cash is still tight every month, check how gross profit is being split. The free Capital Allocation Calculator shows whether Operations is eating so much that nothing is left as a cushion.

Your move this week

Open last month's P&L and last month's bank statement side by side. Write down the profit, then the change in the bank balance.

If they don't match, find the difference. It'll be in the list above. Once you know which one it is, you know what to fix.

Profit is the score. Cash is what keeps you in the game.

FAQ

What's the difference between cash flow and profit? Profit is revenue minus expenses for a period, counted when earned and owed. Cash flow is the money that actually moved in and out of your account during that period.

Can a business be profitable and still have no cash? Yes. Unpaid invoices, prepaid revenue already spent, loan principal, owner draws, growth costs and taxes all pull cash out without reducing profit.

What causes cash flow problems in a small business? Most often slow collections, spending prepaid money before the work is delivered, and growing faster than cash comes in.

How do I improve cash flow fast? Invoice immediately, chase what's overdue, shorten terms for new clients and ask for deposits on large work.

Which matters more, cash flow or profit? Profit tells you if the business works over time. Cash flow tells you if you'll make it to next month. Watch both.