While income and expenses may not always be concurrent with payments, your business may turn a profit even if your bank account is low. You might have money due, or you might have paid cash for stock, equipment and loan repayments. If your business is profitable but you do not have much cash flow, these movements will help you understand the disconnect and identify where you need to take action.
Profit is the amount of money that a company earns after deducting its expenses from its revenue for a fixed amount of time. Cash is the money available to make payments.
For accrual accounting, revenue is recorded when it is earned, but not when cash is collected. Expenses are recorded in the period they relate to, which may differ from their payment date.
For instance, a design business makes £10,000 in revenue from the completion of a job and has £7,000 of costs. It has a profit before tax of £3,000. If the customers pay £4,000 and the business covers the expenses of £7,000, then cash is reduced by £3,000. This is a simplified example, which does not include VAT.
The cash basis accounting system is different. Using it, eligible businesses typically record income when received and expenses when paid. GOV.UK provides a description of cash basis accounting and who can use it. Before comparing your profitability with the contents of your bank account, confirm your accounting method.
If you have unpaid invoices and out-of-normal trading expenses such as stock purchases and payments, there may be less money than your profit indicates.
The wages are not paid by a completed sale until the customer transfers the money. If you are giving credit terms and expecting your suppliers to pay for that, you have to pay for the difference.
Review outstanding invoices, customer disputes and late-paying customers. In some cases, the only thing that's holding up the payment is a missing purchase order or an incorrect address on the invoice.
Money is spent before sales are made. If the accounting model is accrual accounting, unsold stock usually continues to count as an asset instead of an expense, with the appropriate adjustments.
Equipment may also help save cash in real time, and the accounting cost is amortized over time. The tax treatment is an additional calculation.
Loan repayments of principal will appear as cash outflows and reduce the amount owing on the loan. Loan repayments of principal are not ordinary profit and loss expenses, but they do reduce cash. Interest is accounted for separately.
Sole trader drawings do not decrease the profits of the business, but rather the cash. Employers are required to differentiate between salary, dividends, reimbursements and director's loan transactions. Clear bookkeeping records are essential to avoid such movements being confused with trading costs.
Analyze profit and cash flow for the same periods, checking bank balances against statements.
Use your starting and ending cash balance figures. Then review:
Account for payment systems and business savings accounts. Transfers between your own accounts affect the balances in those accounts but do not change the total cash of the business.
Look for any card payments that are processed before the receipts are transferred. If only the bank deposit is recorded, part of the sales and expenses may be concealed.
Visit www.british-business-bank.co.uk for the cash flow guide to understand why profitable businesses can falter until they receive their customers' payments.
Gather cash on a regular basis, budget before taking on extra work, and look at spending commitments.
A weekly cash forecast indicates any cash shortages in time. Start with available cash, add expected customer receipts, and subtract payments that are likely to be made.
Use realistic assumptions. Do not make spending plans based on payments that are habitually late.
Useful actions include:
Update your forecast against receipts and payments weekly. Investigate the consequences of a big customer missing a payment by two weeks. This will show you if you have the flexibility to allow for delays or need to change spending plans.
Sometimes more sales are not the solution. Materials and staff costs may be required before customers can pay for new orders.
These are some of the standard inquiries that arise when the money in the accounts doesn't match the healthy accounts.
Yes. When customers pay after wages, rent and supplier bills are paid, a profitable business may have no funds available. The pressure of stock purchases, equipment payments and debt repayments can create cash shortages. Profitability and payment timing must be treated separately since strong sales may not result in sufficient cash flow today.
Not necessarily. Your accounts may report a profit when cash has been invested in assets or used to repay a loan. Any discrepancies that remain unexplained, however, should be investigated. Compare bank statements, review outstanding bills and check for suspicious activity before determining whether the problem is a timing or bookkeeping issue.
Reevaluate rather than hold back all new purchases. Identify slow-moving items, anticipated demand and supplier lead times. Too much stock means cash is tied up, while too little can bring sales to a halt. A purchasing plan tied to a realistic sales forecast balances availability with affordable stock levels.
When receipts vary or money is scarce, a weekly check is a sensible beginning. Check more often during a cash shortage or a busy trading period. Check the balance today, but compare it with what is expected to be received and paid, and investigate any changes.
Accountancy firms can review your financial data and clarify which transactions are causing the discrepancy between profits and cash balances.
Our accounting and tax service combines financial records and payment requirements. If the numbers are still not making sense, we invite you to talk to us and find out what may need to be done before the next payment is due.