Profit is not cash: why profitable companies run out of money
The income statement can show a profit in the same month you lack money to pay suppliers. It is not a calculation error: profit and cash measure different things, at different times.
You may have lived through this scene. The accountant sends the month's income statement, the bottom line shows a profit, and on the same day you are deciding which bill to pay late. The first reaction is to distrust the accountant. The second is to think money is disappearing. Most of the time, neither is happening. The math is right and the money hasn't disappeared: it just hasn't arrived yet, or it has already gone somewhere else.
Understanding why this happens is one of the most important steps for anyone running a small business. You don't need to be an accountant. You just need to know what each number is counting.
What each number measures
Profit appears on the income statement under the so-called accrual basis. In simple terms: a sale is recorded in the month it happened, even if the customer only pays in 30, 60 or 90 days. The same applies to expenses. September's electricity bill is a September expense, even if you pay it in October.
Cash works differently. It records only the money that actually came into and left the account, on the day it came in and went out. It doesn't matter when the sale was made, it matters when the money landed.
That is why a company can sell well, have a good margin and still end the month with a negative balance. Both numbers are right. They just answer different questions.
Profit tells you whether the business is worth running. Cash tells you whether it will make it to the end of the month.
Where the money gets stuck
When profit and cash don't match, the difference is almost always in one of these four places:
- Sales on credit: the revenue is already on the income statement, but the money is still with the customer. The longer the payment terms you give, the longer your money stays in their hands. Credit card installment sales also fall here, unless you advance the receivables (and pay a fee for it).
- Inventory: the purchase leaves the cash account today and only becomes revenue when the product is sold. Goods sitting on the shelf are money sitting still. For businesses in fashion, parts or building materials, this is usually the biggest drain.
- Loan installments: the entire installment leaves the cash account, but only the interest appears as an expense on the income statement. The part that pays down the debt, called amortization, does not reduce profit. That is why an indebted company can show a profit and have no money at all.
- Investments: a machine, a renovation or a software system leave the cash account all at once, but enter the income statement gradually, through depreciation, over the years.
Table 1 brings these situations together in a hypothetical month. The company sells R$ 100,000, 60% of it on credit, pays all the month's costs, buys inventory for the following month and pays a loan installment. The income statement closes with a profit of R$ 20,000. Cash, in the same period, falls by R$ 70,000.
| Item | Income statement (profit) | Cash flow |
|---|---|---|
| Sales revenue (60% on credit) | 100,000 | 40,000 |
| Costs and expenses for the month, paid in the month | −80,000 | −80,000 |
| Inventory purchased for the following month | not included | −20,000 |
| Loan amortization | not included | −10,000 |
| Result for the month | 20,000 | −70,000 |
Source: prepared by Farol Consulting. Hypothetical figures, excluding taxes.
Notice that no line is wrong. The R$ 60,000 sold on credit will come into the cash account over the next few months. The inventory will turn into sales. The loan will end. But this month, the bank account feels it all at once.
Why it gets tighter as the company grows
It sounds strange, but it is common for a company to run out of money precisely when it is selling more. To sell more, it buys more inventory and often gives longer payment terms to close deals. Both consume cash before bringing money back.
Think of a store that bills R$ 100,000 a month and gets paid in 45 days on average. At any given time, it has something like R$ 150,000 in its customers' hands. If revenue rises to R$ 150,000 with the same terms, that amount goes up to R$ 225,000. That is R$ 75,000 more that has to come from somewhere: from cash, from a loan or from a supplier willing to wait. Growing without planning cash flow is one of the most common ways for a good company to go under.
How to avoid the surprise
There is no magic formula, but three habits solve most of the problem.
Look at both reports side by side, every month. The management P&L tells you whether the business is profitable. The cash flow statement tells you whether it can pay its bills on time. Looking at only one of them is like driving while watching only the speedometer or only the fuel gauge.
Track your payment terms. Write down how many days, on average, it takes to get paid by customers, how many days inventory sits idle and how many days you take to pay suppliers. When the company gets paid after it pays, it is financing operations with its own money. Shortening collection terms, reducing idle inventory or negotiating longer terms with suppliers usually frees up money without having to sell anything more.
Project cash flow for the coming weeks. A simple spreadsheet, with what will come in and go out week by week over the next two or three months, already shows in advance when the squeeze will come. With that lead time, you can negotiate calmly instead of taking the most expensive credit at the last minute.
Frequently asked questions
If the company is profitable, shouldn't the money be in the account?
Not necessarily. Profit counts sales in the month they were made, and the money only arrives when the customer pays. In addition, inventory purchases, debt installments and investments take money out of the account without reducing the month's profit.
Can a loss with positive cash flow also happen?
Yes, and it is just as dangerous as the opposite. A company can have money in the account because it was paid in advance, delayed payments or took out a loan, even while losing money on operations. The balance gives a false sense of security.
Which report should I look at first?
Both, but with different questions. Ask the income statement whether the business is generating a result. Ask the cash flow statement whether you will be able to pay the bills in the coming weeks. If you only have time for one day to day, track cash weekly and the income statement once a month.