How many times have you looked at your profits, but can’t work out why you don’t have the cash in the bank to show for it? Why doesn’t your profit equal your cash? How frustrating is that?
Well, there are lots of reasons why your profit isn’t the same as the cash you have in the bank, and it’s likely that they’re never going to match, so we’re going to look at some of the reasons they don’t agree today.
But first let’s look at the facts
- A profitable business can go out of business if it’s starved of cash.
- A business making a loss can survive because it has access to funds from it’s owners, investors or financiers.
What this tells me is that it’s not enough to just look at your profits, every business owner needs to understand how cash moves through their business, and the key drivers that can affect this flow.
It’s useful to define what profit and cash are:
Profit = Total sales less cost of sales, less running expenses.
Cash = All cash flowing into the business, less cash flowing out of the business
You don’t take the profits to the bank, although that would be awesome!
Your profits are used to pay for any new equipment or other resources to help the business to grow.
We also need to pay our taxes out of profits.
Only after paying for growth and taxes do we has business owners get to take the money home.
So let’s look at some of the ways profits and cash differ:
1. Reporting dates
- Take a look at your profits and find out what dates are being reported.
- The cash you have in the bank is likely to be today’s date, but your profit and loss account is likely to be a date in the past (unless you’re looking at budgets and forecasts, we’ll come onto those later)
- If you’re looking at today’s date, but your profit and loss is for a time period in the past, then the 2 aren’t going to agree.
- Also look at how many months are covered by the profit and loss account. Is it one month, 3 months, 12 months? You’re comparing this with today’s bank balance.
- Is the profit you’re looking at before or after tax?
- This will make a big difference.
- The following taxes do not affect your profits, but do reduce your bank balance:
- Corporation tax
- Income tax
- Class 2 and 4 national insurance (if you’re self employed)
- Capital gains tax
NB: PAYE and NIC if you are an employer do come off your profits, and your bank balance.
3. Asset purchases and sales
- Asset purchases like plant, equipment and vehicles aren’t shown in your profit and loss account, as they are an investment, which will last more than one year.
- They sit on your balance sheet as fixed assets, but the cash to pay for them still goes out of your bank account, unless you’ve got them on finance (see below).
4. Loan and finance repayments
- These repayments don’t affect your profits, but do come out of the bank.
- Only the interest on your loan or finance repayments has an affect on your profits, and makes up some of your running costs.
5. Owners drawings or dividends
- You should only take funds out of your business if you have the profits available (don’t just look at the bank balance)
- You’re taxed on your profits before deducting drawings or dividends, so make sure you’ve set the tax aside before you take cash out for you.
- And check that your business can afford the funds you need for yourself. If you’re taking too much out, your company may not survive.
- What we haven’t looked at is the time it takes for your customers to pay you, or for you to pay your suppliers (and taxes).
- Your profit and loss will include all your sales invoices for the period you’re reporting on, even if they were paid later.
The link between profit and cash is simply timing:
We call this the Working Capital Cycle, but a simpler term is Cash Days, and it shows how long cash is tied up for in your business, and includes:
- How much you have in the bank
- How long it takes for customers to pay you
- How long you’re holding stock before it sells, or doing work before you invoice
- How long it takes to pay your suppliers
- By tweaking each one of these, you can shorten your working cash cycle, and free up your cash.
We can help with this.
So the big question is not – where has my profit gone, but how can I improve my bank balance
Ask yourself these questions:
- Do you know your 7 Key Numbers (the most important numbers to show how your business is doing)
- Do you know your Core Cash Target (how much you need in the bank to cover taxes and overheads)
- Do you know your Cash Days (how long you’re tying up cash in your business)
- Do you have a Cashflow Forecast? (a 12 month report showing the cash flowing in and out of your business)
- Do you keep your accounting software up to date? (We’re big Xero fans, which is the most beautiful and easy to use accounting software in the world)
- Do you have a Cashflow Improvement Plan (set yourself SMART goals and build actions to achieve this)
- Do you have someone Independent to hold you Accountable to your plan?
What you need to do next:
The next step is to look at all the ways that you can improve your bank balance, and there are lots!
We have a dedicated blog on ways to make improvements to your cash.
We also love getting stuck in and helping you to make a plan for improvements, and yes you guessed it, holding you accountable to the plans you’ve made.
Book in a call with us to go through your 7 Key Numbers and build a plan to start to make these improvements.