One of the most puzzling things in business can be why the cash always seems to be so different to the profit.
Although logically you would think they would be quite similar, the reality is that there isn’t a linear relationship between cash and profit. Unless you operate a cash business where you pay for your goods and services in cash daily or weekly, and your sales are paid in cash daily or weekly, you will find that cash and profit diverge over time to the point where they need managing in different ways.
The faster your business grows, the faster cash and profit will diverge – as growth eats cash quickly.
One of the most dangerous things you could every do is manage your business based what’s in the bank, as this doesn’t take account of all the liabilities that are due out, and the income that’s due in.
So it’s really important that you manage your profit using your profit and loss report, and manage your cashflow using your cashflow forecast.
Here are the main reasons cash and profit are so different:
- Sales are made – but cash not collected for 30 – 90 days
- Purchase are made but not paid for until 30 – 60 days
- Assets bought from cash – will not hit the profit and loss
- Depreciation from assets is charged to the profit and loss, but no cash moves
- Loan interest in the profit and loss is not a cash item
- Loan repayments do not hit the profit and loss
- Director’s loan items do not hit the profit and loss
- VAT and corporation tax do not hit the profit and loss but go out of cash
- Cash gets eaten up in stock as the business grows
- Cash gets eaten up in debtors as the business grows