Why profit may not equal cash in the bank

One of the most frequent questions I have been asked by owners of profitable businesses is “where is the cash?” They’ve been trading profitably for a long period but still have a large overdraft! Why?

Some timing differences are understood, expenses are generally incurred before the sales can be made. However there is often an additional lag because accounts record the sales invoiced and expenses incurred in a given period. That this measure of trading does not equate to cash movements can best be illustrated graphically.

A very simplified example shows Stable Ltd

  • Expenses e.g. stock, salary costs are paid for at the end of the month a sale is made
  • Sales invoices are issued at month-end with a strict 40 day credit period
  • The period begins with no cash in the bank

Stable Ltd is making a steady profit (green bars) as shown by the graph and table below:

Graph Income ,Expenses, Profit

 So – steady profits – no problem? Until we look at the cash flow as illustrated in the graph below:  


Stables’ cash flows are negative. The green bars show overdraft (negative cash) increasing then only gradually diminishing despite the (positive) profit. Stable raises and records the sales invoices on 31 January (£1,000) but does not receive the cash until early March. Meanwhile costs such as salaries and stock have to be paid in January.

Although not illustrated, despite having accumulated profits of £2,000, Stable does not have positive cash until September at which point the balance is £250.

It’s important then, to understand and model your cash timings. In the example above, if Stable had an overdraft limit of £750, despite trading profitably it would soon have faced difficulties.

What’s in a number?

I’m a finance professional but would be the first to admit the possibility that numbers can be meaningless and maybe boring. Numbers should be able to give you essential (and interesting) information about your business. The crucial issue is context. So if you’ve ever looked at accounting information and thought ‘so what?’ you are not alone.   

Asleep on the job

Consider this…

The number is 50,000!

??? (yawn/blank look)

It’s Acorn Ltd’s profit for the year!

Is that good?

More information:-

Acorn had sales in the year of £20 million.

Not sounding so good?

More Information:-

Last year Acorn Ltd had a flood at its main premises and made a loss for that year of £1 million.

Forecast loss for this year was £200,000

Not sounding so bad?

More information:-

Most other companies in the same industry made losses in the year.

Now sounding like a better result?

By drilling down to the figures in the context  of what you know about the business and comparing to previous periods, budgets and forecasts,  you obtain information not just about how the business has performed but indications of relevant action points for the future.  

The story

And so we get to the story

Acorn made £250k more than forecast. Because:-

  • Sales had increased by £500K. This was due partly to new sales generated by the newly recruited sales manager. Customer feedback also suggests that Acorn products are considered more reliable than competitors.
  • Product costs had increased by £200k. This was due to the price increase of a component. Engineering consider that this component is of superior quality and more reliable than components used by rivals.
  • Sales manager’s salary was £10k more than planned due to a bonus paid because of sales generation beyond target.
  • Planned training and recruitment costs of £40k had been postponed for 3 months.

Action points

  • Management were preparing to switch to a cheaper component but since the more expensive products provides a competitive advantage will retain. Consider sales pricing increase to compensate for increased cost.
  • Sales Manager was on a temporary contract and will now be offered a permanent contract.
  • Budget for the additional £40k costs which will occur in the next period.

    Coffee Break
    Well earned break


For your business figures to be useful they need to have context. This can be provided by comparing your figures to others in the business (benchmark), previous periods performance, or/and expectations (budgets or forecasts). Although this comparison may in itself provide some interest, in order to be meaningful for directing the business you should also be able to further analyse the figures so as to understand the business detail and respond to the information consequently obtained.