Why your profits are lying to you

Here’s a situation we see more often than you’d expect: a business finishes a strong quarter – good revenue, healthy margins, team firing on all cylinders – and then the owner checks their bank account and feels a knot form in their stomach. There’s not much there.

How does that happen?

The short answer is that profit and cash are not the same thing. Understanding the difference is one of the most valuable things you can do for your business.

Your profit figure is an accounting measure. It captures revenue earned and expenses incurred in a given period. Cash is what’s actually in your bank account. The two can diverge – sometimes dramatically – because of timing.

Think about it this way: you invoice a client in March. The revenue hits your profit figure in March. But if the client doesn’t pay until May, the cash doesn’t arrive until May. In the meantime, you’ve paid wages and overheads for April and May, and likely the cost of materials or goods that went into delivering that work too. The profit is real, but the cash to cover it has been yours to fund all along.

This is what we call a timing difference, and for growing businesses, these differences compound quickly. More sales means more invoices outstanding. More growth means more inventory or people or equipment bought before the revenue arrives to pay for it. The faster you grow, the more working capital you need, and if you haven’t planned for it, cash can disappear even as your profit climbs.

• Overly generous payment terms. Giving clients too many days to pay, or waiting until month-end to bill, can quietly drain your cash position. Could you invoice weekly, or as soon as the work is done? The sooner you bill, the sooner you get paid.
• Slow-paying debtors. Customers paying late is the most common one. If your average debtor days have crept from 30 to 55, you’re effectively giving your clients an interest-free loan. It adds up fast.
• Inventory timing. Businesses that hold stock often pay for it well before they sell it. If your ordering cycles are out of sync with your sales cycles, cash sits tied up on shelves while the bills keep coming.
• Growth eating capital. Ironically, periods of rapid growth are when cash pressure is highest. You need to spend now (on people, systems, stock, assets) to service the business you’re about to do. The income follows later. This is one of the reasons the finance roadmap looks so different at $3M versus $1M: the working capital demands are in a different league.
• Tax surprises. For many business owners, provisional tax instalments feel like a shock each time, even when they’re entirely predictable. If you’re not forecasting tax as part of your regular cash flow planning, it will catch you.

The first step is to build a simple cash flow forecast – not for the whole year, but for the next 90 days. What’s coming in? What’s going out? Where are the pinch points? This doesn’t need to be elaborate. A rough 13-week view is often enough to see trouble coming in time to do something about it.

The second step is to tighten your receivables. Invoice promptly, set clear payment terms, and follow up early. If a client is new or has a patchy track record, don’t be shy about checking in before the due date to confirm payment is on track. Every day you shorten your average debtor days is a day’s worth of cash flowing back into your business sooner. And if chasing invoices is something you’re too busy for, or just hate doing, it’s worth paying someone else to do it. The ROI is almost always there, whether in time saved or cash recovered faster. Direct debits are worth considering too, if your business model allows it.

And the third? Talk to us. Cash flow planning is exactly the kind of thing we can help you with – not just at year-end, but as an ongoing rhythm. Get in touch with your advisor and we’ll walk you through your options.

Knowing your numbers is the foundation. Managing your cash is what keeps the business standing – and growing.