Cash Flow vs Profit: Why Profitable Businesses Can Run Out of Cash
By James Mante · Accounting & Finance Professional
Explore the difference between accounting profit and available cash with a fictional business example.
Profit and cash answer different questions
Profit measures income less expenses under the relevant accounting policies. Cash flow records actual cash moving into and out of the business. A profitable business can still face payment difficulties.
1. Credit sales create a timing gap
A sale may be recognised as revenue before the customer pays. This can increase reported profit without increasing cash at that moment.
2. Inventory and debt payments use cash
Purchasing inventory, repaying loan principal and investing in equipment can reduce cash even when they do not reduce the same period’s profit by an equal amount.
3. Fictional example
A fictional business records £20,000 of sales and £15,000 of expenses, producing £5,000 of accounting profit before tax. If only £8,000 of sales has been collected and £13,000 of expenses has been paid, cash from these customer and expense transactions is £8,000 − £13,000 = −£5,000. This simplified example excludes other cash flows and opening balances.
4. Build a short-term cash forecast
List expected customer receipts and scheduled payments by week. Separate confirmed amounts from assumptions, update the forecast frequently and test what happens if customers pay late.
5. Improve cash discipline
Invoice promptly, review overdue receivables, manage inventory carefully and negotiate realistic payment terms. Avoid confusing temporary cash relief with sustainable profitability.
6. Read the statements together
Review the income statement, balance sheet and cash flow statement together. Changes in receivables, payables and inventory often help explain why profit and operating cash flow differ.
Note: This article is educational. Any example figures and businesses are fictional; accounting treatment depends on the facts and applicable standards.