Why a profitable business can still run short of cash

A healthy profit figure can sit alongside an uncomfortable bank balance. You may be winning work and covering your costs, yet still find that payroll, suppliers and other commitments arrive before the money to pay them. Understanding that gap starts with looking beyond the profit and loss account.

Profit and cash answer different questions

For a business using accrual accounting, revenue and costs are recognised according to when they are earned or incurred, rather than simply when money changes hands. An invoice can therefore contribute to reported profit while the customer has yet to pay it.

Other transactions also affect cash differently from profit. Repaying the capital on a loan uses cash without being an operating expense. Buying equipment creates an immediate payment, while its cost may be reflected in the accounts over time. Ask your accountant to explain the movements that matter in your own figures.

Look closely at the payment cycle

Start with the route from completing work to receiving payment. Who raises the invoice, what information does the customer require and when does their payment process begin? A missing purchase order or an unresolved query can hold up an otherwise straightforward payment.

Review overdue invoices individually. Separate customers who are late from invoices under dispute, and agree who will follow each one up. A total debtor balance tells you how much is outstanding; an aged debtor report helps you see where attention is needed.

Stock and work in progress deserve the same scrutiny. Materials purchased ahead of a job, unfinished projects and slow-moving products can tie up money that is unavailable for the next round of costs.

Build a forecast around realistic dates

A useful cash forecast begins with the current bank balance and shows expected receipts and payments over the coming weeks. Use dates you can explain, rather than assuming every customer will pay immediately or every planned sale will happen.

• List known supplier bills, wages, rent and loan payments
• Include tax payments and irregular annual costs
• Show when outstanding invoices are realistically expected to be collected
• Keep uncertain receipts separate from committed income
• Compare actual movements with the forecast and update it regularly

Run a second version with a major receipt delayed. The purpose is to identify the point at which you would need to act, and to distinguish a temporary timing problem from a continuing shortfall.

Make cash a regular management conversation

Choose a small set of actions with named owners. These might include invoicing promptly, resolving payment queries earlier or reviewing the amount of stock held. Agree changes to customer and supplier terms openly, and assess their commercial impact before making commitments.

MBall’s business services include bookkeeping and management accounts, helping you connect day-to-day records with decisions about the business. A regular review can bring the bank position, outstanding invoices and upcoming commitments into one conversation.

If a cash gap keeps returning, look at the underlying margins and cost structure as well as payment timing. More sales will not resolve every problem, particularly if each new job requires spending before you are paid.

If you would like a clearer picture of your business’s cash position, send MBall an enquiry using the form alongside this article.