Where Is All the Money Going Series: Chapter 3 - Profit Is Not Cash

Future Accounting
3 days ago
4 min read

So where did the money actually go?

This is one of the most common points of confusion in business. Your accountant tells you the business made a profit. You look at the bank account. The money is not there.

Both things can be true at the same time. The business can make a profit and still have very little cash. Profit measures one thing. Cash measures another.

Profit Tells You Whether the Business Made Money

If a business earns $2,000,000 of revenue and incurs $1,700,000 of expenses, accounting profit is $300,000. That tells us the business generated a positive result. It does not mean there is $300,000 sitting in the bank.

Cash Tells You What Actually Moved

Cash flow looks at money physically moving in and out of the business. Not every cash payment is an expense, and not every accounting profit item produces immediate cash. That is why profit and cash can move in very different directions.

A Simple Example

Imagine the business makes an accounting profit of $300,000. During the same year it repays $100,000 of business loans, purchases $80,000 of equipment, increases debtors by $50,000, increases stock by $30,000 and takes an additional $40,000 from the business personally.

Those movements total $300,000. The profit has not disappeared. It has been used: some to strengthen the balance sheet, some to fund growth, some to reduce debt, some withdrawn, and some still sitting with customers who have not paid.

Where Profit Goes When Profit Is Not Cash?

1. Customers haven't paid you yet

You can earn income before the cash arrives. Part of your profit may be sitting in debtors. If debtors increase as the business grows, the business can report stronger sales and higher profits while becoming tighter for cash.

2. Stock has absorbed the cash

Cash can become trapped on shelves. A warehouse full of stock may represent significant value, but it cannot pay next week's wages until somebody buys it.

3. You bought equipment or other assets

The bank account may reduce by the full purchase price immediately, while the accounting expense may be spread over several years through depreciation. The money has been converted from cash into an asset.

4. Loan repayments use cash — but don't all reduce profit

Principal repayments reduce what the business owes. They use cash but do not reduce accounting profit in the same way as an operating expense.

5. Tax has taken cash out of the business

Income tax, GST, PAYG, superannuation and other obligations may not align neatly with when the business earns its income. Tax needs to be forecast and planned.

6. The owners have taken money out

Value may flow to the family through wages, drawings, dividends, distributions, loan accounts, superannuation, personal costs or other benefits.

7. Growth itself can consume cash

Growth often requires cash before it creates it: people, stock, debtors, equipment, premises, marketing and administration.

8. Money may have moved outside the business

Cash may be deliberately used to purchase property, contribute to superannuation, invest, reduce personal debt or build wealth elsewhere.

Follow the Money

A useful exercise is to take the accounting profit for the year and reconcile it to the change in cash. Start with accounting profit, then consider changes in debtors, stock, creditors, equipment purchases, asset sales, borrowings, loan repayments, tax, owner drawings, investments and other major cash movements.

A Family Business Example

Imagine net profit is $400,000. Customers owing money increase by $80,000. Stock increases by $50,000. New equipment purchased for cash is $100,000. Loan principal repayments are $70,000. Additional family drawings are $60,000. The net cash impact is only $40,000.

Suddenly the bank balance makes much more sense. The business made $400,000, but most of it was redeployed. The more important question is whether those uses of cash were intentional and worthwhile.

The goal is not simply to keep as much cash in the bank as possible. It is to use the cash the business generates deliberately.

Strong cash flow gives a business choice. Poor cash flow removes choices and turns decisions into questions about what has to be paid first.

Ask Yourself

Do you know how much cash the business genuinely generated last year?
Can you explain the difference between last year's profit and the movement in the bank account?
How much cash is tied up in debtors?
How much is tied up in stock?
How much debt principal did you repay?
How much did you spend on new equipment or assets?
How much tax did the business and family pay?
How much value did the owners take from the business?
How much did the family invest outside the business?
Is the business carrying enough cash to manage an unexpected setback?
Do you know how much working capital future growth will require?

Most importantly: was the cash the business generated used in a way that moved your family closer to its goals?

3P'S FUTURE PROSPERITY INSIGHT

PRESERVE

Preserving wealth starts with understanding what happens to the cash your business produces. Visibility over debtors, stock, tax, repayments, capital expenditure and owner withdrawals helps identify opportunities to retain more.

PROTECT

Cash flow is one of the first lines of defence in business. Appropriate reserves, manageable debt and forward planning help protect the family from unexpected events.

PROSPER

When the business reliably generates surplus cash, the question changes from 'Where did it go?' to 'Where should it go next?' Debt reduction, growth, property, investments, superannuation, retirement and succession all become possible choices.

What did the business generate, where did that value go, and did it make our family financially stronger?

Book your meeting today and gain clarity on what your business is really producing.

Disclaimer  

This article does not constitute financial advice and is for general information only. It does not take into account any individual’s personal objectives, situation or needs, and is not intended as professional advice. Any similarity to an individual’s personal circumstances and the examples provided in this article is purely coincidental. Any person acting upon such information without receiving specific advice, does so entirely at their own risk.  

Authorisation under an Australian Financial Services Licence (AFSL) is not required in the provision of this article and the author plus Future Accounting Group Pty Ltd is not acting in its capacity as an Australian Financial Services Licence holder 

Liability limited by a scheme approved under professional standards legislation.