Profit vs Cashflow: What’s the Difference?
A business can be making a profit and still be short of cash. That’s usually where the difference between profit and cashflow starts to matter.
Profit tells you whether the business is making money. Cashflow tells you whether there is enough money available when you actually need to pay the bills.
Knowing the difference helps you understand what is really happening in your business.
What is profit?
Profit is what is left after you take your business costs away from the income you have earned.
So, if your business brings in £10,000 and your costs are £7,000, you have made £3,000 profit.
That is a simple example, but it gives you the basic idea.
Profit tells you whether the business is making money from what it does. What it does not tell you is how much money you actually have available in the bank today.
What is cashflow?
Cashflow is the money coming into and going out of your business. Money comes in when customers pay you. Money goes out when you pay wages, suppliers, rent, tax, software, stock and everything else it costs to run the business.
You might send a customer an invoice for £5,000 this month, but if they are not paying you for another 30 days, that money is not in your bank account yet. Your bills may still need paying before that money arrives.
That is where cashflow can start to feel tight, even when the business is making a profit.
How can I be making a profit but not have much money in the bank?
There are a few common reasons.
Your customers haven’t paid you yet.
You can be making plenty of sales and sending out invoices, but until those invoices are paid, you cannot use that money. This is why keeping on top of what customers owe you is so important.
If you regularly have a lot of money outstanding, it can put pressure on the rest of the business.
You’ve had a big payment go out
Some months are simply more expensive than others. You might have a VAT bill, Corporation Tax, insurance, equipment or a large supplier payment due.
The business can still be profitable overall, but one or two large payments can make a big difference to the money available in the bank that month.
The business is growing
Growing a business can make cash feel tighter for a while. You might take on another member of staff, buy more stock, move into bigger premises or invest in new equipment.
You are often paying for those things before the extra income from that growth has caught up, and that does not automatically mean there is a problem.
It does mean you need to know whether the business has enough cash available to cover those costs.
You’ve taken money out of the business
You also need to look at how much money is being taken out personally. The business can be making a healthy profit, but if too much cash is being taken out along the way, there might not be enough left when a large bill comes in.
This is one of the reasons it is useful to know what is coming up, rather than only looking at the bank balance today.
Which matters more: profit or cashflow?
You need to look at both.
Profit tells you whether the business is making money, and cashflow tells you whether there is enough money available to pay what needs paying.
A business can look good on paper and still struggle if the money is not arriving at the right time. This is why we would never look at one number and assume that tells us everything we need to know.
What should I be keeping an eye on?
You do not need to spend every evening looking at your accounts, but you should have a reasonable idea of:
how much money is in the bank
what customers still owe you
what bills are due
what tax needs to be put aside
what your regular monthly costs are
whether any larger payments are coming up
what money you expect to come in over the next few months
This information helps you answer the questions that matter when you are running the business, such as:
Can I afford to take somebody on?
Can I buy that new piece of equipment?
Can I take more money out this month?
What happens if a customer pays me late?
Do I have enough set aside for the tax bill?
Those are much easier questions to answer when your numbers are up to date.
What can I do if cashflow is tight?
The first thing is to work out why.
If the problem is that customers are paying late, you may need to chase invoices sooner or look at your payment terms.
If you have a large payment coming up, look at what else is due around the same time and whether anything can be moved.
Go through your regular spending as well. There may be costs you no longer need or things you can reduce for a while.
It is also worth checking how much you are taking out of the business personally. Sometimes the issue is not that the business is not making enough money, but that too much is leaving the bank account at the wrong time.
If you can see that you may struggle to pay a supplier or another bill, deal with it early. Speaking to people before a payment is late gives you far more options than waiting until the last minute.
The same applies to tax. If you know a bill is coming, make sure you are putting money aside for it as you go rather than hoping there will be enough left when the deadline arrives.
Most importantly, do not wait until the situation becomes urgent before asking for help.
Don’t wait until there is a problem. The best time to look at your cashflow is before things become tight.
If you can see that you might be short of money in a couple of months, you have time to do something about it.
You might need to chase invoices sooner, review what is going out, delay a purchase or make sure enough money is being put aside for tax.
If you only realise there is a problem when a bill needs paying tomorrow, your options are much more limited.
Not sure where the money is going?
If your accounts say you are making a profit but it does not feel like there is much money left, give us a call. We can look at the numbers with you, explain what is happening and help you understand what is coming up.