It sounds impossible. Your profit and loss statement says you made money this year, yet your bank account is nearly empty and payroll is due Friday. This happens to good businesses all the time.
Profit is an opinion. Cash is a fact.
Profit counts sales when you earn them and expenses when you incur them. Cash only counts money that has actually moved in or out of your bank account. The gap between the two is where businesses get into trouble.
Five ways profit and cash drift apart
- Customers pay late. You invoiced $50,000 this month, but if clients pay in 60 days, that money is profit today and cash much later.
- Inventory eats cash. Product sitting on a shelf or in a warehouse is money you have spent but cannot use.
- Loan payments are not expenses. Only the interest shows up on your profit and loss statement. The principal still leaves your bank account.
- Big purchases are spread out. Equipment you paid for in full this year may be expensed over several years.
- Taxes and owner draws. Money you pay yourself and quarterly estimated taxes reduce cash, often without reducing profit.
How to protect your cash
- Look at a cash flow forecast for the next 8 to 13 weeks, not just your monthly profit.
- Invoice right away and follow up on anything past due.
- Ask for deposits on big jobs.
- Keep a cash cushion of at least one to three months of fixed expenses.
- Set aside money for taxes in a separate account every time you get paid.
The bottom line
A business does not fail because it is unprofitable on paper. It fails when it runs out of cash. Watch both numbers.
This is general information, not tax, legal, or financial advice. Rules and limits change, so check with a tax professional about your own situation.