Making a Profit, But Where Has All The Cash Gone? A Small Business Guide to Cash Flow
Have you ever looked at your business accounts, seen a healthy profit, and wondered why your bank balance tells a completely different story?
You're not alone.
It's something lots of business owners experience. The figures show that the business is doing well, but when it's time to pay suppliers, cover wages or prepare for the next tax bill, the money simply doesn't seem to be there.
So, where has it gone?
The answer is that profit and cash flow are two very different things. Understanding the difference can make a huge difference to how confidently you run your business, particularly as we approach the end of the year.
Profit doesn't always mean money in the bank
Your profit and loss report shows how much your business has earned and spent over a particular period. However, it doesn't necessarily tell you how much money you have available to spend today.
For example, you might complete a job in October and issue an invoice for £5,000. That income could appear in your accounts straight away, but if your customer doesn't pay until December, you won't have the cash to show for it in October.
The same applies to expenses. You might record a cost in your accounts before the money actually leaves your bank account. This means your business can be profitable on paper while struggling to cover its immediate expenses.
And if your business is growing, the problem can become even more noticeable. More work often means more materials, higher costs and additional wages to pay before customers settle their invoices.
Growth is great, but it needs cash behind it.
So, where has your money gone?
If your business is making a profit but your bank balance doesn't reflect it, there are a few common places to investigate.
1. Outstanding customer invoices
You've completed the work, sent the invoice and recorded the income, but your customer hasn't paid yet. Until they do, that money isn't available to fund your business.
Keeping track of overdue invoices and following up promptly can make a real difference to your cash flow.
2. Stock and materials
If you've purchased stock or materials that haven't yet been sold or used, some of your cash may be tied up in those purchases. This is particularly relevant for businesses that need to invest in materials or products before they can complete a sale.
3. Tax liabilities
VAT, PAYE and tax on business profits can create a false sense of security if the money is sitting in your current account waiting to be paid to HMRC. It's easy to look at your bank balance and assume you have more available to spend than you really do.
4. Loan repayments and major purchases
Buying a van, investing in equipment or repaying a loan can significantly reduce your bank balance. However, these transactions don't necessarily appear as expenses in your profit and loss report in the same way you might expect. For example, buying equipment may involve capital expenditure, while loan repayments include both capital and interest.
5. Drawings and dividends
If you're a sole trader, money you take out of the business for personal use is treated as drawings rather than a business expense. For limited companies, dividends can reduce the cash available to the business without appearing as an expense in the profit and loss account. These are normal parts of running a business. The important thing is understanding how they affect the money available to you.
Get ahead with a 13-week cash flow forecast
One of the most useful tools for understanding your business finances is a 13-week cash flow forecast.
Rather than simply looking at what has happened in the past, it helps you anticipate what is likely to happen over the next three months.
It doesn't need to be complicated. A straightforward spreadsheet can be enough.
Start with your current bank balance, then map out the money you expect to receive and the payments you know you'll need to make each week.
Include things such as:
Customer payments, using realistic expected payment dates.
Wages and other employment costs.
Supplier invoices and regular business expenses.
Rent, subscriptions and loan repayments.
VAT, PAYE and other upcoming tax payments.
Larger or less frequent costs, such as insurance renewals or equipment purchases.
Once you've accounted for the expected money coming in and going out, you'll have a clearer picture of your projected bank balance each week.
You might discover that December is looking tight because several large payments are due at once, or that January could be difficult because of an upcoming tax bill.
The benefit of spotting these issues early is that you have time to do something about them. You could follow up outstanding invoices, review the timing of non-essential purchases or speak to your bank or suppliers before the pressure builds.
A forecast isn't a guarantee of what will happen, but it gives you the information you need to make better-informed decisions.
Getting paid on time makes a difference
Late payments are one of the most common causes of cash flow pressure for small businesses, but a few consistent habits can help.
Invoice promptly. Don't leave completed work sitting unbilled until the end of the month if you can invoice sooner.
Make payment terms clear. Agree your terms before the work begins and make sure your invoices clearly state the payment deadline.
Follow up overdue invoices. A polite reminder can be all it takes to prompt payment. Set aside time each week to review what's outstanding rather than waiting until the situation becomes urgent.
Keep an eye on your customer balances. Knowing who owes you money, how much they owe and how long it's been outstanding helps you identify potential problems early.
You don't need to be confrontational to be effective. Often, a friendly and consistent approach is enough to keep payments moving.
Don't let your tax money disappear into everyday spending
Another useful habit is to separate money earmarked for tax from the money you use to run your business. This could mean transferring an appropriate amount into a separate savings account whenever customer payments arrive. The amount you need to set aside will depend on your business structure, taxable profits, VAT position and other circumstances, so it's worth getting advice on what is appropriate for you.
When a tax payment becomes due, the money is already there rather than having to be found at the last minute.
How long could your business keep going?
Here's another question worth asking yourself:
If no more money came into your business tomorrow, how long could you continue paying your essential bills?
This is a useful way to think about your cash reserves. Consider your available cash alongside the essential costs you would still need to cover, such as wages, rent, loan repayments and critical suppliers. The answer will vary from business to business. A company with reliable monthly income may need a different level of cash reserves from one that relies on large, irregular projects. What matters most is understanding your position, knowing what your business needs to keep operating and recognising when your cash buffer is getting smaller.
Your numbers are only useful if they're up to date
Cash flow management becomes much harder when your bookkeeping is behind.
If your sales invoices haven't been recorded, supplier bills are missing or bank transactions haven't been reconciled, it's difficult to know exactly where your business stands, and if your financial information is weeks out of date, your forecasts may not reflect what's really happening.
Keeping your bookkeeping up to date is about having reliable information that helps you make decisions throughout the year. You don't have to wait until there's a problem to start paying attention to your cash flow. In fact, the best time to understand your numbers is when you still have options.
Let's make your numbers work for you
Making a profit is important, but knowing where your money is going and having enough cash available to meet your commitments is just as vital. A clearer picture of your finances can help you plan ahead, prepare for tax payments, manage customer debts and make decisions with greater confidence.
At Whortleberry Accounting, I help businesses stay on top of their bookkeeping and understand their financial position, giving them the information they need to manage their money more effectively.
If you'd like help getting your bookkeeping up to date, understanding your cash flow or putting a forecast in place, I'd love to hear from you.
This article is for general information only and does not constitute financial or tax advice. The right approach will depend on your individual circumstances.
Comments