Profit is not the same as cash
Cash flow is the movement of money into and out of the business over time. Profit is the difference between revenue and costs for a period, measured by when sales are earned and costs are incurred. Because money rarely arrives at the same moment the work is done, a business can be profitable on paper and still be unable to pay its bills.
A hypothetical example
Suppose a small business starts a month with $2,000 in the bank. During the month it completes a job and sends a $6,000 invoice with 30 days to pay. To do the job it pays $2,500 for materials, $800 for rent and $1,200 in wages, which is $4,500 in total. It also collects $1,000 owed from an earlier job.
On an accrual basis, the job earned $6,000 against $4,500 of costs, a profit of $1,500. But the cash picture is different: $2,000 plus $1,000 received, minus $4,500 paid, leaves negative $1,500. The business needs about $1,500 it does not have, even though it did well. Next month, when the $6,000 arrives, the problem disappears, unless a bill falls due first. The numbers are invented, but the pattern is very common.
Common causes of cash shortages
- Customers who pay later than expected
- Paying suppliers or staff before being paid
- Buying more stock than sells quickly
- Large one-off costs, such as equipment, insurance premiums or tax bills
- Seasonal swings in sales
- Owner withdrawals that are higher than the business can currently support
- Fast growth, which often needs money for materials and wages before the new revenue appears
Build a simple cash flow forecast
A forecast does not need to be sophisticated. A spreadsheet or even a notebook can do the job.
- Choose a period. Weekly works best for a tight business, monthly for a steadier one. Look 8 to 13 weeks ahead, or 12 months for the longer view.
- Start with opening cash. Use what is actually in the bank.
- List expected money in. Record when you expect payments to arrive, not when you issue invoices. Be cautious: assume customers pay a little later than their terms.
- List money out. Include rent, wages, supplier bills, loan payments, tax payments and irregular costs.
- Calculate closing cash. Opening cash plus money in, minus money out. That becomes next period’s opening cash.
- Update it regularly. Replace forecast figures with actual ones and extend the forecast forward.
If any period shows a negative closing balance, you have found a gap while there is still time to act. The forecast is an estimate, not a promise, and it will be wrong in places; its job is to show direction and risk.
Speed up money coming in
- Send invoices promptly and clearly. A tidy invoicing process often shortens the time to payment.
- Set payment terms you can live with, and state them before work begins.
- Consider deposits or staged payments for larger jobs.
- Follow up politely and early; having a routine for late payments saves awkward conversations later.
- Offer convenient ways to pay, and make sure payment processing is reliable.
Slow down or smooth money going out
- Ask suppliers about longer terms or splitting large orders. Many are open to supplier negotiation, especially with a good payment record, though they are not obliged to agree.
- Keep stock modest. Money sitting on a shelf is not available for bills, so sound inventory management frees cash.
- Spread irregular costs by setting aside a fixed amount each month.
- Time large purchases for when the forecast shows comfortable cash.
- Align payroll basics, such as pay dates, with the rhythm of incoming money where the rules allow.
Build a buffer
Many owners aim to hold a reserve covering some weeks or months of essential costs. How much is right depends on your business, your risk and how predictable your sales are. Building one takes time, so start with a small, regular transfer into a separate account.
If cash gets tight
Act early. Talk to suppliers, landlords and lenders before a payment is missed; they usually respond better to a warning than to silence. Short-term borrowing can bridge a temporary gap, but it adds repayments and costs, so be sure you can repay it from reliable income and not by borrowing again. Compare options carefully and avoid borrowing more than the business can handle.
Regular reading of your balance sheet and cash records shows trends sooner. For decisions involving credit, tax payment plans or legal obligations, consult a qualified accountant, as rules and options vary by location.