Profitable on Paper, but Short of Cash: A Small Business Guide to Cash Flow
Oct 1
5 min read
Have you ever looked at your profit and loss report, seen that your business has made a profit, and then wondered why there doesn’t seem to be much money in the bank?
It can be confusing, but it doesn’t necessarily mean something is wrong. Your profit and your bank balance measure two different things.
Your profit and loss report shows the income your business has earned and the expenses it has incurred during a particular period. Your bank balance simply shows how much cash is available at that moment.
Understanding the difference can help you plan ahead and avoid unexpected cash shortages.
Where has the profit gone?
Depending on how your accounts are prepared, a sale may be included in your profit before your customer has actually paid you.
For example, you may send a customer an invoice today, but they might not pay it for another 30 or 60 days. The sale could already be included in your profit, even though the money has not yet reached your bank account.
This can affect growing businesses in particular. More sales can mean:
More unpaid customer invoices
More stock or materials to purchase
More wages and other costs to pay
More money needed before customers make payment
Growth is positive, but it often requires cash before it generates cash.
Five common places your profit may be sitting
When a business is profitable but the bank balance is lower than expected, the difference can often be found in one or more of these areas.
1. Unpaid customer invoices
You have completed the work and recorded the sale, but the customer has not paid you yet.
Keeping on top of overdue invoices can make a significant difference to your cash flow.
2. Stock and materials
Money may be tied up in stock, materials or supplies that have already been purchased but have not yet been sold or used.
Although these items have value, you cannot use them to pay your bills until they help generate a sale.
3. Money owed to HMRC
Your bank balance may include money that will eventually need to be paid to HMRC, such as VAT, PAYE or tax on your profits.
It can look like available cash, but it is important to remember that it is not all yours to spend.
4. Loan repayments and equipment purchases
Loan repayments reduce the amount in your bank, but only the interest element will usually appear as an expense in your profit and loss report.
The same can apply when purchasing equipment. The money leaves your bank immediately, but the accounting treatment may mean the full amount does not appear as an expense at the same time.
5. Money taken out of the business
For a sole trader, drawings reduce the bank balance but are not a business expense, so they do not reduce the profit shown in the accounts.
The same principle applies to dividends taken from a limited company. They reduce the company’s available cash but do not appear as an expense in the profit and loss report.
None of these things automatically means the business is being managed badly. They are all normal parts of running a business. The important thing is understanding where the money is and keeping an eye on how the position is changing.
Looking ahead with a 13-week cash flow forecast
A simple 13-week cash flow forecast can help you see what may be coming over the next three months.
It does not need to be complicated. It can be created in a straightforward spreadsheet and updated each week.
Start with your current bank balance. Then, for each week, include the money you realistically expect to receive.
Try to use the date customers normally pay rather than assuming everyone will pay on the invoice due date.
Next, include your expected payments, such as:
Wages
Rent
Supplier payments
Loan repayments
Software and subscriptions
VAT and PAYE
Income Tax or Corporation Tax
Insurance and annual renewals
Any planned equipment purchases
This will give you an estimated closing bank balance for each week.
You may notice that several large payments are due around the same time. If you identify this early, you have more time to chase unpaid invoices, review payment dates or make suitable arrangements.
If you only notice it a few days before the payments are due, your options may be much more limited.
Once the forecast has been set up, it should only take a short amount of time to review and update it regularly.
Making it easier for customers to pay you
Following up unpaid invoices can feel uncomfortable, but it is a normal part of running a business.
Many customers are not deliberately avoiding payment. Sometimes they simply need a reminder.
A few simple habits can help:
Send invoices promptly once the work has been completed.
Show the exact payment due date on the invoice.
Include the correct bank details and payment options.
Agree your payment terms before starting the work.
Review unpaid invoices at the same time each week.
Follow up overdue invoices politely and consistently.
A friendly reminder shortly after an invoice becomes overdue will usually be more effective than leaving it for several months and then sending a frustrated email.
Keep tax money separate
Money collected or set aside for tax can easily be mistaken for available spending money when it remains in the main business account.
For example, if a VAT-registered business charges VAT at the standard rate, the VAT element of the payment collected will eventually need to be paid to HMRC, subject to any VAT the business can reclaim.
Tax on business profits also needs to be planned for, even though the payment may not be due for several months.
Using a separate bank account for tax savings can make this much easier to manage. Each time money is received, you can transfer an appropriate amount into the separate account and leave it there until the payment is due.
The percentage you need to save will depend on your business and personal circumstances, but regularly putting money aside can help prevent a future tax bill from becoming a crisis.
How many weeks could your business manage?
It can be useful to understand how long your business could continue paying its essential costs if no further money came in.
Start by listing the costs the business must pay to continue operating, such as:
Wages
Rent
Loan repayments
Essential suppliers
Software and subscriptions
Regular household drawings, if you are a sole trader
Work out an approximate weekly total and compare this with the cash genuinely available to the business.
There is no single correct figure. A business with reliable monthly income may need a different level of cover from one that relies on large, irregular projects.
What matters is knowing your current position and whether it is improving or getting tighter.
Up-to-date bookkeeping helps you make better decisions
A cash flow forecast is only useful when it is based on accurate and recent information.
If your bookkeeping is several weeks or months behind, it becomes much harder to know:
Which invoices are overdue
What bills are coming up
How much tax needs to be put aside
Whether the business can afford a planned purchase
Whether the bank balance is likely to fall
Bookkeeping is about much more than keeping tidy records. It should give you information you can actually use to make decisions in your business.
Final thoughts
Your profit has not necessarily disappeared.
It may be sitting in unpaid invoices, stock or equipment, or it may already have been used for loan repayments, tax, drawings or other commitments.
Understanding where it has gone and looking ahead before cash becomes tight can help you feel much more in control of your business finances.
If you would like help understanding your figures, improving your bookkeeping or creating a simple cash flow forecast for your business, please get in touch.
07352 454764
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