Understanding Cash Flow – Why Your Profit is Not Cash in the Bank

If your company is generating revenue and bringing in plenty of profit, then why is there not a lot of extra cash in the bank? Many people equate bringing in money with holding onto it, but when running a complex operation with money coming in and going out simultaneously, it’s often not so simple. In this article, we aim to explain what is cash flow in business and answer other questions that business owners often ask.

My accountant and financial reports say that my company is generating revenue and bringing in a lot of profit, but I never seem to have enough cash on hand. Where is my money and how do I ensure that I have enough going forward?

One of the biggest examples on the cash flow statement is inventory. When you purchase inventory, it does not show up as an expense until you sell it. This means you may have a large portion of your cash, or profit, tied up in inventory. Rather than showing up as cash, you may now own your inventory outright, which will become more revenue and profit when you sell it, but in its current form you can’t use it as you would cash – to pay bills or fund employee payroll.

Another example is paying down debt. When you begin to repay the principal on debt, that is not an expense, it’s money that you owe. Similarly, when you borrow money, that is not considered your income, even if you have a sudden influx of cash on hand. Although it’s not income, that repayment on a loan does not show up as an expense. Reducing your debt by reinvesting profit into paying down the principal balance might not appear to show profit at first, but is a necessary step for any business to become profitable.

While neither of the above examples show up as an expense on your profit and loss statement, they do show clear gains in profit, even though cash is flowing out of your bank account and leaving your business temporarily cash poor.

Cash Flow Projection

To ensure that you’re better able to make sense of where your profit is, and retain enough money to cover your expenses, a cash flow projection is an ideal tool. Cash flow projections are more comprehensive than a simple profit and loss statement, because they include all cash coming in and going out. It takes into account inventory payments, capital equipment purchases that don’t show up as an expense, and payments made to business owners.

While noting money going out, a good cash flow projection will also clearly show cash inflows that a profit and loss statement do not account for, such as borrowing money or selling an asset.

Because of the complex nature of how businesses are run these days, it’s important to have a profit and loss report, as well as a cash flow forecast. They’re different tools that you will use for different purposes, for instance a cash flow calculator. And if you’re stuck wondering where your money is and how you can get more cash on hand, it’s important to perform cash flow analysis and investigate all available documentation to ensure you know where your money is coming from, and going to.

This information was provided by David Safeer. David is a globally recognized expert in cash flow optimization and the founder of David Safeer International, which educates and advises accountants and CFOs on cash flow and profit maximization strategies for their clients. His work has impacted hundreds of businesses with revenues from $1 million – $20 million in 40 countries. David teaches accountants how to grow their revenue with cash flow advisory services through his cash flow advisory certification program and mastermind groups. Schedule a meeting with David to discuss cash flow management here.

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