Sales and profit are two very different things – as a business owner, you can find yourself without the cash to pay bills despite making sales you knew were profitable. You may also be startled to discover that strong cash flows from sales deliver little profit.
A cash flow forecast tracks cash flowing in and out of your business. The timing of these flows allows you to figure out at what points throughout a year you have lots of cash or small amounts of cash. This helps in making the right decisions, such as when to buy assets or when to prepare for cash shortfalls.
Cash flow is essential to the survival of your business – arguably more so than profit in the short term. Profit may be essential in the longer-term, but in the short-term cash is needed to pay bills and operating costs.
For example, if you’re a plumber with good cash reserves, you can survive until your business becomes profitable. However, if your business runs out of cash, you’ll need to find a solution quickly to avoid going bankrupt.
Profit is the money left in your business after all your expenses have been paid. An income statement (also referred to as a profit and loss report) reveals what profit your business made last month or last quarter. Your profit’s detailed in two figures, namely:
Note that net profit still isn’t the final ‘bottom line’ profit until all taxes have been paid.
All businesses need profit to grow. Your profit can be allocated to (among other purposes):
The gap between a cash flow forecast and an income statement (profit and loss report) reflects the different ways business owners record financial data.
A cash flow forecast only records actual cash transactions. Cash flow can be boosted by inputs other than sales, such as:
These sources boost cash levels to fund your business but aren’t profit.
Unlike the cash flow forecast, the income statement includes ‘book figure’ inputs that don’t involve cash outlays but do affect the profit calculation, such as:
These scenarios help explain the gap between cash flow and profit.
“The profit and loss shows a $50,000 profit, but the cash in the bank is only a small amount, how come the figures don't match up?"
This is a pretty common example, especially when a business buys equipment or vehicles
“We’ve been extremely busy these past few months. Sales are booming – but I can’t see any profit.”
Inexperienced business owners can easily confuse ‘being busy’ with being profitable, but there’s a very clear distinction between them. Your profit is always what’s left after all costs have been deducted.
If you haven’t calculated your selling prices correctly, your ‘thriving’ business may in fact be operating at a loss. The cash flow may seem great, but the profit and loss account reveals the true picture.
The critical lesson here is to never set your prices until you know all the costs involved. You might end up operating at a loss or at a very small profit level which is unsustainable. 
It’s quite possible to run out of cash or go bankrupt by taking on too much business too quickly, even though each sale is profitable. This is called over-trading – and businesses that sell on credit rather than cash terms are more at risk.
Reasons businesses can run out of cash include:
Cash flow is all about the timing of money inflows and outflows.
If you expend significant cash to pay operating expenses and miscalculate the actual time to collect customer receivables, or your business is poor at collecting on overdue accounts, you can easily use up all your cash paying suppliers and other bills while waiting to collect amounts owed by customers.
Make sure you’re on the right track with this online checklist.
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(02) 9837 6148
25 Alford Street, Quakers Hill NSW 2763PO BOX 300, Doonside NSW 2767
enquiries@hyaccounting.com.au
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