When running a business, your main aim is probably to make money, after all, we all need to make a living. However, are you seeing a distinct lack of money in your bank account, even though your company is making a profit? In which case, where has it gone? 
 
Knowing the difference between how much cash you have and how much profit you’re making is an essential part of running a successful business. Cashflow is a sure-fire way to see if a company is doing well as this figure cannot be manipulated, whereas profit margins can be calculated and interpreted in many ways. 

The Importance Of Cashflow 

If you don’t have a good cashflow you can’t buy the essentials needed to run your business or pay yourself and your staff. For a small business, having cash in the bank that can be invested back into your business is vital for long term survival. Using cash to invest in training, product development, or technology, such as a new website or card machine, can help you go from ticking along to high growth. 
 
If you’re looking for an investor to boost your finances or a bank loan, you will need to demonstrate that your revenue, net income and operating cashflow are all healthy, because if a business can support itself, it has the potential for growth. However, if you have bad cashflow, you may be perceived as a high risk and therefore not worth investing in or lending to. 
 
It is possible to have a positive cashflow, but not be a profitable business. 

The Importance Of Profit 

In the long run, if you are not a profitable business, you will fail. 

So Where Is My Cash? 

It’s not as simple as looking at how much profit you’ve made year-on-year to see where your cash is, as it will be tied up in many different guises. 
 
Bank account – you will need enough cash in your company account to cover your business commitments, such as paying employees (including yourself), buying stock or materials, and paying your taxes. 
 
Stock or materials – stock levels need to be managed carefully. Too much stock that can’t be sold is not helping your business to grow, but not enough stock and you will miss out on potential sales. By increasing your sales and carefully balancing your stock levels, you can get more cash flowing into your bank account. 
 
Fixed assets – anything your business owns that isn’t stock, such as computers, furniture, equipment, vehicle, etc. is a fixed asset. The outgoings for these items will result in less cash in your bank account, but if the expenditure improves your productivity or services, then it was worth the investment. However, the purchase of a fixed asset doesn't hit your profit line – only the annual depreciation does. Don’t forget the value of these assets will depreciate over time, which will need to be reflected in your profit and loss statement. 
 
Accounts receivable – the amount of money you are owed by your customers will result in less cash in your bank account. Chasing up debt is a good way to improve your cashflow and boost your bank account. 
 
Loans – if you have borrowed any money in the form of business loans, this cash inflow doesn’t hit your profit line. So you may have MORE cash than profit. 
 
Gross profit – if you don’t mark up your products enough, or charge enough for your services, your gross profit margin will not be great. Make sure you cost things accordingly and never forget to allow for enough gross profit to make your business a success. 
 
Waste – to avoid wasting money, make sure you don’t spend too much on overheads or make costly mistakes, as this cash could be in your account instead. 
 
Withdrawn cash – this is the amount of cash you take out of your business for yourself. Just because there is money in your company account doesn’t mean it’s there for the taking. Never forget your future company outgoings, such as rent, utilities, tax bills, VAT, and supplier liabilities. Withdrawing too much money from your company could result in your inability to make these payments, and ultimately this could cause the demise of your business. 
 
Your reward – the amount of profit you achieve after paying all your liabilities is your reward. As your profit grows and the amount you can withdraw as a sole trader or pay yourself in salary and dividends as a limited company will increase. 

Worked Example 

To give you a basic worked example: 
 
ABC Limited has prepared its accounts to 31st December 2020. It shows a profit (before tax) of £35,000. 
 
The director wants to understand why he only has £11,200 in the company bank account. 
 
The answer to this lies largely in the Balance Sheet of the company accounts. 
 
Profit (before tax) 
£35,000 
The company purchased a new piece of equipment during the year costing £10,000. This has been treated as a Fixed Asset as it has a useful life of greater than one year. This means that this hasn’t been included in the Profit and Loss. 
(£10,000) 
Depreciation has been included on the new piece of equipment based on a useful life of 4 years (therefore £10,000 / 4 years = £2,500). This is a non-cash accounting adjustment. 
£2,500 
The company is owed £17,500 from customers (shown in the accounts as debtors). 
(£17,500) 
The company owes VAT of £1,200. 
£1,200 
Cash in bank 
£11,200 
 
Contact Us to see how we can help you get your cashflow under control and to discuss where the difference between your profit and cash is! 
 
Written by: 
Nicola J Sorrell - Effective Accounting 
Founder | Xero Champion | IR35 Expert 
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