Two different questions
Profit asks whether the business earned more than it cost over a period. Cash asks whether there is money in the bank today. Both matter, and they answer different questions.
Timing is one reason they diverge, because money and work rarely move together. You deliver a job in March and are paid in May. You buy stock in January and sell it in June. You owe a tax or supplier payment on a date that has nothing to do with when customers pay you.
Timing is not the whole story. Profit includes some costs that involve no cash leaving the business in the period, such as depreciation, and it leaves out some cash movements altogether: spending on equipment or other long-term investment, and money coming in or going out through loans and other financing. Changes in working capital, meaning what customers owe you, what you owe suppliers and what you hold in stock, sit between the two.
A worked example
A small agency completes a large project in one month and sends an invoice. On paper the month is very profitable. The customer pays in two months’ time. In the meantime the agency pays its people and suppliers from its existing balance. The profit is real, and the cash has not arrived yet.
Where cash tends to hide
- Unpaid invoices. Money earned but not yet received.
- Stock and work in progress. Money spent ahead of the sale.
- Upcoming obligations. Tax, payroll and supplier payments that fall due on fixed dates.
- Investment and financing. Buying equipment or repaying a loan uses cash without appearing as an ordinary cost in the profit figure.
- Money taken out. Director pay and dividends leave the same balance everything else is paid from.
A simple way to look ahead
You do not need a complex model to begin. Start with today’s bank balance. List what you expect to receive in each of the next several weeks, and only the things you are genuinely confident about. List what you must pay in the same weeks. The running balance is a forecast. It cannot guarantee what will happen, but it can show likely pressure points earlier, while there is still time to respond. Update it regularly and compare it to what really happened: the gaps teach you how reliable your assumptions are.
Questions to ask each month
- Which invoices are overdue, and what is our plan for each?
- What is the lowest the bank balance is likely to reach in the next few months, and when?
- Is there a cost coming that is larger than usual, and is money set aside for it?
- If our biggest customer paid a month late, what would happen?
A note on advice
Cash planning depends on your customers, costs and obligations, so treat this as a starting point. For help building a forward view of your own cash, talk to us.