Cash flow vs profit: why a profitable business can still run out of money

A business can make a profit and still run out of money. Profit is what you have earned once your costs are taken off. Cash flow is the money that actually moves in and out of your bank account. The two run on different timing. You can invoice £10,000 today and be in profit, but you cannot pay a supplier with an invoice. You can only pay them with money that has arrived.

Profit tells you whether the business is worth running. Cash tells you whether it can keep running while you wait to be paid. You need both, and most owners only watch one.

Key Takeaways

Profit and cash in plain words

Profit is the income your business has earned over a period, minus the costs that belong to that period. It shows up on your profit and loss account.

Cash flow is the money coming in and going out. It tells you whether there will be enough in the bank when wages, rent, supplier invoices and tax fall due.

The key difference is when each one is counted. Most limited companies must use what is called accrual accounting. That means a sale counts when you send the invoice, and a cost counts when you receive the bill. It does not wait for the money to move. Many sole traders and partnerships can use cash basis accounting instead, which records income and costs when money is received or paid. Even then, the profit figure can include money you have not yet collected, so the gap does not disappear.

A useful way to put it: profit tells you whether you have made money. Cash tells you whether you can keep trading.

The three layers of profit

You will hear three kinds of profit. They are worth knowing, because each answers a different question.

• Gross profit is what you sell, minus the direct cost of what you sold. For a café, that is takings minus food and drink costs.
• Operating profit takes off the running costs too, such as rent, wages and utilities.
• Net profit is what is left after everything, including interest and tax. This is the bottom line, and it is what most people mean when they say "profit".

None of these is cash. All three can look fine while the bank balance falls.

Why profit and cash drift apart

There are a handful of repeat offenders. Almost every case of "profitable but short of money" comes from one or more of them.

1. Customers pay after your costs are due

This is the big one. A sale on credit is profit today, but cash only when the customer pays, which may be weeks or months later. Meanwhile your own bills keep arriving.

We see it most with firms that sell to other businesses. Larger customers often take 30, 60 or even 90 days to pay, while suppliers want paying within about 14 days. That leaves you funding the gap out of your own pocket. Each new order looks profitable, but you are paying for the work for two months before you see a penny.

It is also worth knowing where the law stands. If you and your customer agree a payment date, it must usually be within 60 days for business deals (30 days for public authorities). A longer period is allowed, but it must be fair to both sides. If you do not agree a date at all, the law treats the payment as late 30 days after the customer gets the invoice, or after you deliver the goods or service, whichever is later. You can then claim interest and debt recovery costs. Many owners never use this, partly because chasing feels awkward. But you have done the work and earned the money.

The scale of the problem is large. The government estimates that businesses are owed around £26 billion in late payments at any given time, and that late payments lead to around 14,000 business closures a year.

2. Stock is cash sitting on a shelf

When you buy stock, the money leaves your bank straight away. But it only counts as a cost against profit once you sell it. Until then, your cash is sitting in boxes. Overstocking is one of the fastest ways to open a gap between profit and cash.

3. Loan repayments

When you repay a loan, two things happen. The interest is a cost, so it reduces your profit. The part that pays back what you borrowed does not reduce profit. But both leave your bank account.

Take a repayment of £2,000 a month, of which £500 is interest and £1,500 is paying back the loan itself. Your profit only takes the £500 hit. Your bank balance drops by the full £2,000.

4. Equipment and vans

If you buy a van for £24,000, the cash goes out on day one. Your accounts spread the cost over its life. Written off over four years, that is £6,000 a year, or £500 a month, taken off your profit. The bank feels the whole £24,000 at once.

5. Tax bills

Tax is based on profit, but it is paid later. For most small companies, corporation tax is not due until nine months and one day after the end of the accounting period. VAT and loan repayments can also take a large amount of cash out in one go, without showing up as an equivalent cost in that period's profit.

The danger is spending the profit before the tax bill arrives. If you are already behind with HMRC, our guide to HMRC Time to Pay arrangements explains how spreading a bill works.

6. Growth

This one surprises people. Taking on more work usually means paying for staff, materials and stock before the customer pays you. So a growing business can find its cash stretched at exactly the moment its profit is rising.

Taking on more work than you can comfortably finance with the cash you have is sometimes called overtrading. The new work may be perfectly good. The margin may be healthy once it is complete and paid. But you still need enough cash to reach that point. In our experience, most cash crises in profitable businesses happen while they are expanding, not while they are shrinking.

A simple worked example

Here is a small business that invoices £40,000 of work in March, on 60-day payment terms. It also buys a new van outright for £24,000. Wages, rent and supplier payments come to £28,000. It collects £18,000 from invoices raised back in January.

March	Profit	Cash
Work invoiced in March (paid in May)	+£40,000	£0
Payments received for January invoices	Not counted again	+£18,000
Wages, rent and suppliers	−£28,000	−£28,000
New van (£24,000)	−£400 (one month's wear and tear)	−£24,000
Result for the month	£11,600 profit	£34,000 less cash

On paper, March was a good month. In the bank, the business is £34,000 worse off than when it started, and it will not see the £40,000 until May.

If it has no reserves and no borrowing facility to cover the gap, it could struggle to pay wages or suppliers in April, even though it is trading profitably. Nothing went wrong with the business. It simply could not see the timing.

A second, smaller example

Say your quarter shows a £20,000 profit. During the same three months:

• Customers owe you £12,000 more than before.
• £5,000 more is tied up in stock.
• You spend £4,000 on new equipment.
• You repay £2,000 of a loan.

That adds up to £23,000 (12,000 + 5,000 + 4,000 + 2,000). Your cash has gone down by £3,000, despite a £20,000 profit. The profit figure is not wrong. The money has either not arrived yet or has been used in ways that do not show as a cost.

Can it work the other way?

Yes. A business can have plenty of cash and still be making a loss. Cash can come from a loan, money from an investor, selling an asset, customers paying deposits for work you have not yet done, or simply paying your suppliers late.

That can be perfectly sensible for a while, for example if you have raised money to launch something new. But if you rely on borrowing or one-off injections to cover ongoing losses, it is not sustainable. So look at where the cash came from, not only the total in the bank.

It also helps to separate two kinds of problem. A cash flow problem is usually about timing. Money is due from customers, or cash is tied up in stock, and the position recovers when it arrives. A profitability problem goes deeper. The business is not earning enough to cover its costs even when customers pay on time. The fixes are different, so it is worth knowing which one you have. Look at several months, not one bad week.

Warning signs of a cash squeeze

Cash trouble tends to leave clues before you miss a payment. Watch for these:

• Profit is steady or rising, but the bank balance keeps falling.
• Customers are taking longer to pay than they used to. Invoices left unpaid for 60 or 90 days are a particular worry.
• You are holding more stock compared with what you sell.
• You lean on the overdraft or a credit card for normal bills.
• Suppliers are chasing you more often.
• You feel a knot in your stomach every time VAT, payroll or a tax payment comes round.
• You delay essential purchases because the money is not there.
• You use the next customer payment to cover bills that are already overdue.
• You do not know what your bank balance is likely to be in four weeks.

One of these on its own may have a simple explanation. Several together usually mean it is time for a closer look.

The single most common cause is customers slowly taking longer to pay. In one case we know of in the wider market, a business's customers stretched from paying in the high 30s of days to the high 60s as it grew. That alone soaked up a large amount of cash, and none of it showed in a profit figure that looked fine.

Simple ways to keep cash healthy

None of this needs a finance degree. These habits do most of the work.

Keep a rolling cash forecast

A cash forecast is a list of what you expect to come in and go out, and when. Cover at least the next 12 or 13 weeks. Use realistic dates, not the dates on the invoices. Add wages, supplier bills, tax, loan repayments, rent and subscriptions. Then add a cautious version in which your biggest customer pays late.

It will not predict everything. But it gives you warning while you still have choices. And a simple weekly habit helps: compare what you expect to receive over the next 30 days with what you have already committed to pay. If there is a gap, you have time to act. If you only find it when a payment bounces, you have a crisis. I would check cash weekly and profit monthly.

Get paid faster

• Send invoices the moment the work is done, not at the end of the month.
• Make your payment terms clear before you start.
• Shorten them if you can. Moving from 30 days to 14 days is a common first step, and "due upon receipt" on the invoice helps.
• Ask for a deposit or part-payment up front on bigger jobs, or bill in stages, so you are not funding the whole job yourself.
• Follow up the day a payment becomes overdue.
• Make it easy to pay online.
• Consider a small discount for early payment if your cash position allows it.

If a customer always needs chasing, ask whether they are really worth it. A customer who gives you plenty of work but pays late may be worth less than the sales figure suggests.

Check before you give credit

Before you let a new customer owe you money, run a credit check. It helps you set a sensible limit and sensible terms. For a sole-trader customer, a personal credit report can also give you a clue about how promptly they pay.

Slow down the money going out

• Negotiate better terms with your biggest suppliers. If your largest customers push for longer terms with you, you should be pushing for decent terms with your own suppliers.
• Do not hold more stock than you need.
• Think about leasing equipment or vehicles rather than buying outright. It spreads the cost and keeps cash in hand.

Keep a buffer

A cash reserve turns a shock into an inconvenience. A sensible target is between one and three months of running costs. Start with something realistic and build it steadily, rather than waiting for a month when there happens to be plenty left over.

It also helps to set aside tax money as you go. Money that is already spoken for is not really yours to spend.

Plan growth before you say yes

Before you take on a big order, work out what you must spend before the first payment arrives, when the customer is due to pay, and how long they typically take in practice. Then check you can still meet your existing bills in the gap. Finding out halfway through a job that you need another £30,000 leaves you with fewer and more expensive options.

When borrowing makes sense, and when it does not

Borrowing can bridge a temporary gap that you understand. A well-timed overdraft, revolving credit facility, business credit card or loan can cover a slow-paying customer or a stock purchase before a busy season. Invoice finance lets you draw cash against unpaid invoices instead of waiting 30, 60 or 90 days.

But be honest with yourself. Borrowing adds repayments and interest to your future cash going out, so it can make a deeper problem worse. If the real issue is thin margins or continual losses, borrowing only delays the conversation. Before you borrow, build a forecast, be clear why you need the cash, and make sure you could still afford the repayments if things go less well than planned.

Our view is that the best time to arrange a facility is while the business is healthy, not when the bank balance is already at the edge. Lenders look at profit and cash together, and a business that can show it understands both is in a much stronger position. Our guide on how to improve cash flow goes further on the practical steps.

Frequently Asked Questions

Is cash flow the same as profit?

No. Profit is what you have earned after costs, counted when you invoice and when bills arrive. Cash flow is the real money moving in and out of your bank. A business can be profitable and short of cash, or loss-making and cash-rich for a while.

Why doesn't my bank balance match my profit?

Because profit includes sales you have not yet been paid for. It also leaves out some cash movements, such as paying back the loan itself or buying equipment, which reduce your bank balance without fully showing as costs.

Which matters more, cash or profit?

Neither on its own. Cash decides whether you can survive the next few weeks, since you cannot pay wages or HMRC with profit that is still tied up in unpaid invoices. Profit decides whether the business is worth running over the long term. A business that keeps spending more than it earns will run out of cash eventually too.

How often should I check my cash?

Weekly is ideal for a small business, and monthly at the very least. The earlier you spot a shortfall, the more options you have.

Can a growing business run out of cash?

Yes, and it is one of the most common ways it happens. Growth means paying for staff, materials and stock before new customers pay you. Work out the cash you need before you say yes to a large order.

If your profit looks healthy but your bank balance does not, Deplexifi helps UK businesses find finance that fits the gap, and we will tell you plainly when borrowing is the wrong answer.

Treating profit as money you can spend. Profit includes sales you have not been paid for yet, and it ignores things like loan repayments, equipment and tax that still leave your bank account.