Cash flow vs profit: why one matters more

Profitable businesses run out of money and close. It happens every year, and the owners are usually genuinely surprised, because they had been watching the wrong number.

Profit and cash are not the same thing, and confusing them is one of the more expensive mistakes a business owner can make.

The difference, plainly

Profit is income minus expenses over a period. It is an accounting result, and it counts things when they are earned or incurred, not when the money moves.

Cash flow is what actually went into and out of your bank account.

You can be profitable and broke at the same time. Here is how.

You invoice a customer $50,000 in September. On the profit and loss, that is income in September. The customer pays you in December. Meanwhile you have paid your staff, your suppliers and your rent through October and November. On paper you had a strong September. In practice you spent three months funding someone else's business.

The four places cash quietly disappears

Debtors. Money you have earned and not been paid. The longer your average collection time, the more of your own capital is tied up in other people's businesses.

Stock. Cash converted into things on a shelf. It looks like an asset because it is one, but it is not available to pay wages.

Tax and super. GST you have collected is not your money. Neither is PAYG withholding, and now that super has moved to a seven day cycle after each payday, super leaves faster than it used to. Businesses that treated the old quarterly gap as spare cash are feeling this one.

Growth itself. This is the cruel one. Growing usually means paying for stock, staff and capacity before the revenue arrives. The faster you grow, the harder the squeeze. Plenty of businesses have been killed by a large order they could not fund.

What to watch instead

Three numbers, checked regularly, will tell you more about your survival than a profit figure will.

Cash on hand, and how many weeks of costs it covers. If you know you have six weeks of runway, you can make decisions. If you do not know, you are guessing.

Debtor days. How long, on average, between invoicing and being paid. If that number is creeping upward, your cash position is deteriorating even if sales look fine.

A rolling forecast, thirteen weeks out. Not a budget for the year. A week by week view of what is coming in and going out. Thirteen weeks is far enough ahead to act and close enough to be realistic.

The point

Profit tells you whether the business model works. Cash flow tells you whether you will still be here to find out. You need both, but only one of them will put you out of business this quarter.

If you have never seen a proper cash flow forecast for your own business, it is usually a revealing exercise, and not always a comfortable one.

This article is general information only and does not take your particular circumstances into account. It is not tax, financial or legal advice. Rules change and how they apply depends on your situation, so please get advice specific to your business before acting. Spectrum Business Management, CPA and registered BAS agent, Mt Gambier and Australia wide.