Profit is good. You sold something for more than it cost you to provide it. Happy days.
But it’s not the full story. I’ve sat in enough corner offices to know that a cheerful profit number can hide a dismal bank balance, and that’s a serious problem.
You see, profit doesn’t mean the money is sitting in your bank account. Sales, profit and cash seem like different ways of measuring the same thing when you’re starting out, particularly when the business is small and you see transactions yourself.
But they measure different things. Conflating them leaves you wondering why a profitable month makes it harder to pay the bills.
You can make sales without making a profit. That’s bad.
You can make a profit while running short of cash. That’s really bad.
You can have plenty of cash in the bank and lose money simply by operating. That only ends one way.
Put in the effort to understand what each number is telling you.
Profit and cash move differently
Imagine you run a small consulting business. This month you complete $10,000 worth of work and incur $6,000 in costs running the business and delivering it. On those numbers you’ve made $4,000 profit, which tells you your business model is on the right track.
But suppose your customers paid only $4,000 as a progress payment. The remaining $6,000 is due next month, while $5,000 of your costs have already left the bank. The work produced a $4,000 profit but your cash balance went backwards by $1,000.
There’s nothing wrong with this. But realise this: money coming into your business rarely operates on the same timetable as money going out.
This is how a profitable business finds itself short of money.
Your bank balance can lie to you
There’s another problem. Even when the cash has arrived, some of it may already have a job.
Tax is the obvious example. Money sits in your bank account for weeks or months before the payment falls due. Until then it looks exactly like every other dollar, pound or euro in the account.
Unless you’ve allowed for the upcoming payment, it’s easy to treat that money as available and spend it on something else (the easiest way to manage this is to quarantine an amount in a separate bank account, and I write about that approach here).
The same applies to any known commitment. You might have $10,000 in the bank today, but if $7,500 has to leave during the next three weeks, you don’t really have $10,000 available for new equipment, marketing or yourself.
Checking the bank balance isn’t enough. The balance tells you what’s there today. It doesn’t tell you what needs to be there next Tuesday.
Profit doesn’t answer that question either. Profit tells you whether the business is earning more than it costs over a period. That’s information you need. If you repeatedly sell something for $500 when it costs $550 to provide it, that’s a problem that needs attention
Cash tells you this: whether you have enough money, at the right time, to meet the commitments you’ve made.
Look forward
You don’t need fancy accounting software to manage this. You just need a simple view of the next few weeks.
Start with the cash you have today, then add the money you reasonably expect to receive and when you expect it.
Against that, record what you know needs to leave the business and when. Include the obvious regular bills, then add the irregular payments that are easy to forget because they don’t arrive every week or month.
The timing matters as much as the amount. Knowing a customer owes you $5,000, due at the end of next month, is no comfort when your supplier needs $3,000 now.
When you see those cash movements ahead of time, the bank balance becomes useful. You see how much of today’s cash is already committed, when the tight periods are coming and whether a purchase you can technically afford today will leave you exposed two weeks from now.
A basic spreadsheet is enough to start. It doesn’t need to predict every transaction or extend years into the future. Its job is simply to stop known payments from surprising you and to show when expected receipts arrive too late to cover them.
Keep watching profit because you need to know whether the business makes economic sense. But watch the timing of cash as well. A profitable business still needs enough money in the bank on the day the bills fall due.
