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Profit Is Not Cash

I received this question from a client:

Let’s say you have a loan you are repaying. It is $10,000 total—$9,000 to principal and $1,000 to interest. The only thing that shows on your Profit & Loss Statement is the interest. The principal is reduced on the balance sheet. But if you are managing the company off the P&L, you are going to be light $9,000, so it’s not really an accurate picture. What’s going on?

Many of you probably have the same question. You manage profitability from the profit and loss statement. You manage cash and cash flow from the balance sheet.

Each month, your profit and loss statement tells you whether you earned a profit or had a loss. It does not tell you how much cash you have. You must turn your profits into cash by collecting your receivables and paying the expenses incurred to produce those revenues.

Unfortunately you can be profitable and go bankrupt. How? Here are some examples:

A customer doesn’t pay you for your profitable work.
You grow profitable so quickly that you run out of cash.
You are drawn into a lawsuit (through no fault of your own) for profitable and correct work that you performed or someone getting hurt on a project.

Profitability does not ensure business survival. Many businesses have a month or two months that are not profitable. Others have an unprofitable quarter and work the rest of the year to make up the losses. What they aren’t realizing, is that they are also working the rest of the year to generate the cash they need to survive that quarter the following year.

So what do you do? First, be profitable. Without profits, you won’t generate the cash you need to survive and thrive.

Second, determine your cash needs each month. Calculate this by looking at sales, collections, the costs to produce goods and services, and overhead costs.

Sales count. However, collections on those sales count more. If you collect COD then the sales for the month should equal the collections for the month. However, many collections are 30 to 60 and sometimes even 90 days after the work was completed. You might have a sale in January, produce and deliver the work in February, and not get paid until March.

Determine when you must pay for the cost of producing your products and services. For example, many times you’ll have to pay payroll expenses for production before you get paid for the goods and services. You may also have to pay your material suppliers or subcontractors before you get paid for your work.

Finally, determine your monthly overhead costs. These are generally the same each month and must be paid whether you sell or collect.

Let’s look at an example. You sell a $30,000 project in January. Then you look at the cash needs for February. Since you have no cash received for this job, your collections are zero. In this case assume that your payroll and production costs are $5,000. They are all due in February. In this case, assume that your monthly overhead is $10,000.

For this example, you’ll need to fund $15,000 to produce the $30,000 sale that you get paid for in March.

Smart business owners manage both profitability and cash. You need both for a successful business.

Published: May 9, 2013
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Ruth King

Ruth King is a serial entrepreneur, having owned seven businesses in the past 30 years. Ruth has been instrumental in helping business owners understand and profitably use the information generated from the financial segment of their businesses. Recently, she was the instructor for ICE, the Inner City Entrepreneur program in conjunction with the Small Business Administration. Ruth has written many manuals and books, and she was the 2006 USA Best Books Winner for Entrepreneurship and a finalist for the Independent Publisher Awards (IPPY) for her first book, “The Ugly Truth About Small Business.” Her best-selling book “The Courage to be Profitable” was published in 2013.