You make 4,000 and your cash falls by 6,000. Why it happens and how to avoid running out of money while profitable.
Key findings
- Selling 10,000 with 6,000 of costs makes 4,000 of profit, but if you have not been paid, cash falls by 6,000.
- Customers, stock, suppliers, investments and loans separate profit from cash.
- Growing fast needs cash: many profitable businesses close because they run out.
Making a profit and running out of cash
It is one of the most common surprises in running a business: the profit and loss account says you are making money, but there is less and less in the bank. It is not an accounting error. Profit measures what you earn when you sell; cash measures when money actually comes in and goes out.
A simple example
You deliver a service for 10,000 with 6,000 of costs you have already paid. You have made 4,000. But if the client has not paid yet, what you are owed rises by 10,000 and your cash falls by 6,000: you have paid the costs and collected nothing.
If you also pay your own suppliers later, say the same 6,000, cash does not move: no money comes in or goes out until each side pays.
What separates profit from cash
- What customers owe you. If you sell on credit and grow, more and more money is waiting to be collected.
- Stock. Inventory you have bought and not yet sold is money that has already gone out.
- What you owe suppliers. Paying later helps cash; paying sooner hurts it.
- Investments. A machine is paid for today, but the profit and loss account spreads it over several years (depreciation). That is why depreciation reduces profit without reducing cash.
- Loans and money the owners take out, which move cash without being profit or expense.
For example, with a profit of 4,000, 3,000 more in stock and 1,000 of depreciation, cash only rises by 2,000.
Why growing can be dangerous
A fast-growing business sells more, but it also has more unpaid invoices and more stock. It has to fund that growth before it collects. Many profitable businesses close just when they are doing best, because they run out of cash.
What you can do
- Get paid sooner: deposits, shorter terms, payment reminders.
- Only buy stock you will sell soon.
- Negotiate payment terms with your suppliers.
- Forecast your cash for the coming weeks, not just your profit.
Go from profit to cash with the profit vs cash flow calculator and plan ahead with the cash flow forecast.