Here’s a simple exercise. Imagine your business invoices £100 and incurs costs of £80. How much cash do you have in the bank?
Most people say £20. But it depends entirely on timing. When does the £100 come in, and when does the £80 go out?
Say your customers pay you promptly, and you can also delay paying your suppliers. In that case, you might have all £100 sitting in the bank for a while.
Now flip it around. Suppose you’ve paid your suppliers, but your customers are slow to pay you. As a result, you could have nothing left. You might even end up overdrawn, despite technically making a £20 profit.
Three Numbers, Three Different Stories
People use three numbers almost interchangeably: revenue, profit, and cash. However, they aren’t the same thing at all.
Revenue is money coming in. It’s the total value of what you’ve sold, so it tells you how busy you’ve been, and little else.
Profit is what’s left after costs, on paper. Accountants match your income against the costs of earning it, usually over a month, a quarter or a year. Profit therefore tells you whether your business model works.
Cash is what’s actually sitting in your bank account right now. Above all, it tells you whether you can pay wages on Friday.
Each number answers a different question. If you confuse them, you make decisions based on the wrong answer.
Why Profit and Cash Rarely Match
A healthy-looking profit and loss account doesn’t guarantee a healthy bank balance. After all, it’s the bank balance that pays the wages.
Several everyday things pull the two apart.
Unpaid invoices. You record the sale the day you send the invoice. However, the cash arrives 30, 60 or even 90 days later. Meanwhile, you show a profit but have nothing to spend.
Stock. When you buy stock, the cash leaves immediately. Yet the cost only hits your profit when you sell the item. A warehouse full of unsold goods is cash you can’t touch.
Equipment and vehicles. Say you buy a van for £30,000. Your profit and loss account spreads that cost over several years, but your bank balance takes the whole hit on day one.
Loan repayments. The capital part of a loan repayment doesn’t count as a cost in your profit. Still, it leaves your bank account every month.
Tax bills. Corporation tax, VAT and PAYE all fall due on fixed dates. Those dates rarely line up with when your customers pay you, so tax often lands at the worst moment.
Owner drawings and dividends. When you take money out of the business, it doesn’t count as a cost. Yet it reduces your bank balance just the same.
Any one of these can open a gap between profit and cash. Together, they can open a chasm.
A Simple Example With Real Numbers
Take a small business selling £100,000 of services across a year, with £80,000 of costs. Profit comes to £20,000, a healthy 20% margin.
Now add timing. Customers take 60 days to pay, but the business pays its wages and suppliers within 30 days. So the business must fund 30 days of costs before it collects a penny. On £80,000 of annual costs, that’s roughly £6,600 of cash tied up at any moment.
Next, grow the business by 50%. Revenue rises to £150,000, costs rise to £120,000, and profit rises to £30,000. But the cash tied up rises to roughly £9,900.
In other words, the business made £10,000 more profit, yet it needs about £3,300 more cash to fund the growth. If you scale those numbers up tenfold, the problem turns serious.
A Profitable Business Can Still Run Out of Money
This surprises many owners. Yet it happens all the time.
Picture a growing business. Orders pour in, and sales double. Profit looks excellent. But the business must buy materials and pay staff before customers settle their invoices. Every new order therefore needs more cash up front.
The faster the business grows, the more cash it consumes. Eventually, the bank balance hits zero, even though the profit and loss account looks fantastic. Advisers call this overtrading, and it’s one of the most common reasons profitable businesses fail.
Growth doesn’t fix a cash problem. In fact, it often makes one worse.
The Working Capital Cycle
Every business runs on a cycle. First, you spend money on materials and wages. Then you deliver the work and invoice the customer. Eventually, the customer pays, and the cycle starts again.
The length of that cycle decides how much cash you need. Say you pay wages weekly but customers pay you every 60 days. In that case, you must fund about two months of costs out of your own pocket. If you double the size of the business, you double the funding you need.
Now look at what shortens the cycle. Faster invoicing helps, and so do quicker collection, deposits, and longer supplier terms. Each one reduces the cash tied up in the business. As a result, a shorter cycle means less funding and more cash in the bank.
Many owners assume they need a loan or overdraft when the real fix sits in their own processes. Finance costs money, whereas better habits cost nothing.
Why Buyers Care About All Three
If you plan to sell your business one day, all three numbers matter. However, they matter in different ways.
Revenue shows a buyer the size of the business. Profit shows what they can earn from it. Cash shows how well the business turns profit into money they can actually take out.
Buyers examine this closely. For example, they check whether profit converts into cash reliably, month after month. A business that reports strong profits but constantly struggles for cash raises questions. Where is the money going? Are customers really paying? Is the profit real?
Buyers also work out how much working capital the business needs to operate. If it needs a lot, they may ask you to leave cash in the business at completion. Otherwise, they may reduce the price. Either way, weak cash management costs you money on the day you sell.
Strong cash conversion works the opposite way. It gives a buyer confidence that the numbers are real. And confidence, as ever, earns a higher price.
Five Practical Ways to Improve Your Cash Position
The good news is that you can improve cash without selling more or cutting costs. In fact, most of the gains come from better habits.
1. Invoice on time. Don’t wait until month-end. Instead, send the invoice the moment you finish the work. Every day you delay pushes payment back by a day.
2. Agree better payment terms. Ask for deposits or stage payments on larger jobs. Where you can, shorten your standard terms from 30 days to 14.
3. Chase overdue invoices promptly. Set a routine. For example, call before the due date, then again the day after. Polite persistence works.
4. Negotiate with suppliers. Ask for longer terms where you have a good track record. However, don’t damage the relationship to get them.
5. Forecast your cash. Build a simple 13-week cash flow forecast and update it every week. Because it shows problems weeks before they arrive, you still have time to act.
None of these steps costs much. Together, though, they can free up serious cash.
Warning Signs to Watch For
How do you know if profit and cash are drifting apart? Watch for these signals:
- Your overdraft keeps growing, even though you’re making a profit.
- You delay paying suppliers just to make payroll.
- Customer invoices regularly run past their due dates.
- Last quarter’s profit has vanished, and you can’t explain where it went.
- Your accountant keeps mentioning “working capital.”
Any one of these deserves a closer look. If several appear together, a problem probably already exists.
Read All Three Numbers Together
The real skill isn’t tracking one number. Instead, it’s reading all three side by side.
Each month, compare your revenue, your profit and your closing bank balance. Then ask simple questions. Did profit turn into cash? If not, why not? Where did the money go?
Over time, you’ll spot patterns. Perhaps cash always dips in January because of tax bills. Maybe one large customer always pays late. Once you see the pattern, you can plan for it.
This habit takes an hour a month, yet it can save you from a cash crisis. It also makes your business far more attractive when the time comes to sell.
The Bottom Line
Revenue is vanity, profit is sanity, cash is king. Only cash tells you if you can pay this month’s bills. You can be profitable on paper and still run out of money, so know the difference before it catches you out.
How H&Hendricks Can Help
Untangling revenue, profit and cash sits at the heart of H&Hendricks’ Optimising Performance service. We also help improve the numbers behind all three.
Ashley Bancroft is a founding Partner of H&Hendricks. A qualified Chartered Accountant and specialises in finance, strategy and entrepreneurship, with particular focus on value creation.
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