Profit vs Cash flow

“But if we made that much why don’t we have more money in the bank?” is a common response I hear at the end of each month when I send out or meet clients to go through their month end reports. Hopefully the following will help explain the difference between Profit and Cash flow for small businesses.

Cash Flow is the imagesreal time stream of money in and out of your business. This is actual money in the bank, petty cash tin and till. Each day, month and year you receive an amount of cash and pay out cash. This is a real measure of how your business is performing and whether you will be able to pay your bills over the coming months. This is a very dynamic measure which also takes into account things that aren’t shown on the profit and loss report such as prepaid revenue, capital investment, receipts from debtors, sales of non current assets, payments to creditors, prepaid expenses, loan repayments, vat payments/receipts  and purchases of non-current assets.

Profit is income from selling your products or services minus all your expenses. These figures don’t take into account whether you have paid for the expenses or been paid for your services/product. This measure only looks at income and expenses at a certain point in time and takes into account such non cash measures as depreciation, accrued revenue, stock loss/gain, and accrued expenses.

In the real world you buy a retail item for £1000 and sell it for £2000 then you have made £1000 profit. If you have paid the supplier but haven’t been paid by the customer your accounts still show a profit of £1000 but your cash flow is £1000 down until the customer pays. Over time this situation becomes worse as you have to pay the VAT difference of £200 to HMRC meaning you are £1200 down in cash terms if you add in your utility bills, wages, advertising etc this can cause very real cash flow issues.


Positive ways to affect Cash flow

  1. Prepare cash flow projections * for the next month, quarter and year, if you are on shaky ground shorten this period to the next week. Knowing there may be cash flow issues coming up can help you to tackle them in advance.
  2. Invoice your customers promptly
  3. Review your invoicing terms and the timing of your invoices – If you are invoicing monthly items could you switch to invoicing on the first day of the month instead of the last.
  4. Don’t assume every customer has to be given 30 days. If someone asks for credit carry out a credit check to determine who should be given this luxury.
  5. If a customer has a bad payment record instead of turning them away insist on cash on delivery
  6. Ask for deposit payments at the time the order is placed
  7. Implement and maintain strict credit control measures
  8. Pay your supplies on time but not in advance of their terms
  9. Renegotiate your terms with your suppliers
  10. If you are going to pay a supplier outside their terms let them know in advance to maintain trust in the relationship
  11. Control your costs – review regularly what cash  is going out and how you can reduce this figure
  12. Bank money that you receive promptly
  13. Manage your stock levels – Don’t hold on to old stock get rid of it for the best price you can


So which one is more important? 

The answers is both are, your profit figure will give you a picture of how you business has performed that month and whether you are hitting your monthly & annual targets. Your profit is also the figure that your annual tax bill will be calculated on by your accountant.

Your cash flow reports will tell you if you are able to meet your financial commitments that are coming up over the next few months and keep the business running.

* Don’t forget when you are working on your cash flow projections to look at taxes, vat and one off expenses such as insurances which can make a huge dent in one months cash flow.

This article assumes that you are using Accrual Accounting which means that you record your income and expenditure in the month they happen. It doesn’t take into account when the cash is received or paid out. So if you invoice in January the income shows in the profit and loss report in January and the outstanding amount shows as a debt. When the invoice is paid in April the amount you are owed reduces but your profit and loss report isn’t affected.