Cash flow and profit are not the same thing

In one paragraph

Profit is what you earned over a period. Cash is what is in the bank today. A business can be profitable on paper and still fail, because bills arrive before customers pay.

Profit is calculated when a sale is made, not when it is paid for. Send an invoice on 30-day terms and the profit appears immediately; the cash appears a month later, or two, or never.

Meanwhile wages, rent, VAT and suppliers do not wait. The gap between paying out and being paid is the working capital cycle, and the faster you grow the wider it gets — because growth means buying more stock and doing more work before any of it is paid for.

This is why growing businesses fail

It is counter-intuitive and it is the single most useful idea in business finance. A business that doubles its orders may have to double its stock and wages this month against invoices that settle in two. Profitable, and out of cash.

A cash-flow forecast is simply cash in and cash out, month by month, showing the running balance. Its value is not accuracy — it is seeing the month you run out, while there is still time to do something.

How to actually use it

• Forecast twelve months of cash, not profit. Look for the lowest point, and arrange the facility before you need it — borrowing is far easier while you are still solvent.
• Shorten the cycle: invoice the day the work is done, take deposits, chase early, and negotiate longer terms with suppliers than you give customers.

Where it breaks down

• A forecast is a set of assumptions. It tells you what happens if things go as expected, which is why the useful version has a pessimistic column too.

If you are being examined on it

If a case study business is growing fast and worried, the answer is nearly always cash flow rather than profitability. Say which and why.

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