Profit vs cash flow: why profit isn't cash

Many owners find out the hard way that a good profit report does not pay the wages. Profit and cash are both real numbers, but they measure different things, and they often move at different speeds. This lesson explains the difference and why it matters.

Revenue, profit and cash are three different numbers

Revenue is the amount your business earns from sales before any costs come out. business.gov.au describes it as the amount earned “before expenses, tax and other deductions”, also known as turnover.

Profit is what is left after your expenses:

• Profit = revenue minus expenses

Profit is measured over a period, such as a month, a quarter or a year. It answers the question: “Did the business earn more than it cost to run?”

Cash is the money in your bank accounts on a given day. Cash flow is, in business.gov.au’s words, “the money flowing in and out of a business”. The simplest way to see the change in cash over a period is:

• Closing cash = opening cash plus cash received minus cash paid out

Cash answers a different question: “Can I pay the bills that are due now?”

Why profit and cash move apart

Most accounting software reports profit on an accruals basis. That means a sale counts as revenue when you invoice it, and a cost counts as an expense when you receive the bill, not when money changes hands. Some small businesses report on a cash basis instead. Ask your bookkeeper which yours uses, because it changes what your profit report shows.

On an accruals basis, these common timing differences pull profit and cash apart:

• Customers pay later than you invoice. The sale is in your profit this month, but the cash may not arrive for 30, 60 or more days.
• You pay costs before you are paid. Wages, materials and fuel for a job often go out weeks before the customer pays.
• You buy stock. Stock you have paid for but not sold sits on the balance sheet. It is cash gone, but not yet an expense.
• You buy equipment. A vehicle or machine is paid for up front, but its cost reaches your profit report slowly, as depreciation, over its useful life.
• You repay a loan. Only the interest is an expense. The rest of each repayment reduces cash but does not reduce profit.
• You collect money that belongs to someone else. GST you collect and PAYG you withhold from wages sit in your bank account for a while, but they are not yours to spend.
• You take money out as the owner. Depending on your structure, drawings or dividends reduce cash without being an expense.

None of these means something is wrong. They are normal. The problem comes when you plan your spending around profit and forget the timing.

Worked example

A Brisbane landscaping business has about $600,000 in yearly sales, or around $50,000 a month. March is a busy month. To keep it simple, all figures exclude GST and we ignore depreciation.

The profit view for March

Item	Amount
Work invoiced (revenue)	$60,000
Wages, materials, fuel, rent and other running costs	$50,000
Profit	$10,000

The cash view for March

Item	Amount
Cash in the bank on 1 March	$20,000
Cash received from customers	$42,000
Running costs paid	$50,000
New ride-on mower, paid in full	$10,000
Cash in the bank on 31 March	$2,000

Closing cash is $20,000 plus $42,000 minus $50,000 minus $10,000, which is $2,000.

So the business made a $10,000 profit in March, yet its bank balance fell by $18,000. Two timing differences explain the whole gap:

1. It invoiced $60,000 but collected only $42,000. Customers now owe it $18,000 more than they did at the start of the month.
2. It paid $10,000 for the mower. That is cash out, but not a March expense.

Profit of $10,000, minus the $18,000 still owed by customers, minus the $10,000 mower, equals minus $18,000. That matches the fall in cash exactly.

If a $15,000 supplier bill falls due in early April and customers are slow again, this profitable business could struggle to pay it on time.

What the numbers may tell you

Reading profit and cash side by side can tell you a lot:

• Profit up, cash down. Often a timing issue: customers paying slower, more stock on hand, or a large purchase. It may also be a sign of growth using up cash, because you pay for the extra work before you are paid for it.
• Profit down, cash up. You may be collecting old invoices faster than you are making new sales, or delaying your own bills. That can look comfortable for a while, but it does not last.
• Both falling. The business may be spending more than it earns. This needs attention quickly.
• Cash always tight, even in good months. Look at how long customers take to pay and how much cash is tied up in stock. The lesson on debtors and creditors covers this in more detail.

Where to find these numbers

• Profit appears on your profit and loss statement.
• What customers owe you, stock and equipment appear on your balance sheet.
• Cash in and out appears on your bank statements and on a cash flow statement. business.gov.au has a free cash flow statement template, and the cash flow lesson shows how to use one to plan ahead.

Your accounting software can usually produce all three reports for any period. The business.gov.au cash flow guide suggests keeping good records and using digital accounting tools, which can show your cash flow in real time.

When to talk to an accountant or bookkeeper

Talk to your accountant or bookkeeper if:

• your profit report and bank balance tell very different stories and you can’t see why
• you are not sure whether your reports are on a cash or accruals basis
• you are planning a large purchase and want to know how it will affect both profit and cash
• you have been making a profit on paper but keep running short of cash to pay tax, super or suppliers

A bookkeeper can make sure your records are up to date. An accountant can help you read them and plan around the timing.

Where this matters for business finance

When a business applies for finance, a lender will usually look at both profit and cash. A profit report shows whether the business earns enough over time. Bank statements show how cash actually moves. A business that is profitable but short of cash because of a temporary timing gap is in a very different position from one that is losing money. If losses are the real cause, borrowing adds a repayment without fixing the problem. See when borrowing is not the answer.

Important things to know

• Profit is not cash. Plan your spending around your expected bank balance, not your profit report.
• Growth can use up cash. More sales often mean more wages, materials and stock paid for before customers pay you.
• Some money in your account is not yours. GST and PAYG withholding are owed to the ATO. business.gov.au suggests setting aside money regularly so you have funds ready when tax payments are due.
• Timing gaps are predictable. A cash flow forecast shows when they will hit, so you can act early.
• Watch for patterns. If you keep running short, read cash flow warning signs and talk to your accountant. For how short-term assets and bills fit together, see what is working capital? Terms used here are also in the glossary.