Profitable on Paper, Nothing in the Bank
Why profit and cash are not the same thing, and the four places they come apart.
Your accountant says you made $140,000 last year. Last Thursday you moved money around so a supplier payment would clear.
Both of those are true at the same time, and the gap between them is where a lot of Australian businesses quietly get into trouble.
Can a profitable business run out of money?
Yes, routinely, and it is one of the most common ways businesses fail in this country. Around 47% of Australian SME insolvencies list poor cash flow or financial management as a contributing factor, and a good number of those businesses were profitable on paper right up until the end.
Profit is an opinion. It is a calculation, and a good accountant can produce several different versions of it from the same set of numbers, all of them legitimate. Cash is a fact. It is either in the account or it is not.
You need both. But only one of them pays wages on the 15th.
This is a different problem from being unprofitable. If the profit itself is the issue, that is the six places the money goes.
The four places profit and cash come apart
1. Debtors: you made the sale, you have not been paid
You invoice, you book the revenue, the profit appears in the report. The money arrives 52 days later, or it does not.
More than half of all invoices in Australia are paid late. Average debtor days sit somewhere between 45 and 65 against standard 30-day terms, and the average business loses around $2,400 a month to late payment, which is close to $28,000 a year.
That $28,000 is not a rounding error on a $1.5M business. On a 6% net margin it is a third of your annual profit.
2. Stock: cash converted into things sitting in a shed
Every dollar of stock is a dollar you have already spent that has not yet earned anything. It does not show up as a cost until it sells, so a business can look profitable while steadily converting its bank balance into shelving.
3. Capital purchases and loan principal
You buy a $60,000 vehicle. Your P&L sees depreciation, maybe $12,000 in the first year. Your bank account saw $60,000.
Same with loan repayments. The interest is a cost and appears in your profit. The principal is not a cost and does not appear anywhere in the report, and it comes out of the account every single month.
This is the one that catches people. You can be paying down $4,000 a month of principal that never shows up on the document you use to judge how the business is going.
4. Tax and super: money that was never yours
GST collected, PAYG withheld, superannuation accrued. It sits in your account and it looks like your money, and it is not.
When cash gets tight, this is the account people dip into, because it is there and nobody has rung about it yet. It is also the fastest way to turn a cash flow problem into a compliance problem.
What a month actually looks like
Here is the same month seen two ways. A business reporting a $12,000 profit and going backwards $9,300 in the bank.
| Line | In the P&L | In the bank |
|---|---|---|
| Sales invoiced | $125,000 | |
| Cash actually received | $103,000 | |
| Cost of sales | ($71,000) | ($71,000) |
| Wages and overheads | ($42,000) | ($42,000) |
| Stock purchased, not yet sold | ($9,300) | |
| Loan principal | ($4,000) | |
| GST and PAYG paid to the ATO | ($8,000) | |
| Vehicle purchased | ($1,000) depreciation | ($22,000) |
| Depreciation only | ($1,000) | |
| Result | $12,000 profit | $9,300 out |
Illustrative figures.
Nothing in that table is wrong or unusual. It is a normal month in a growing business. And an owner looking only at the left column would tell you the business is going well, because it is.
How far behind are you actually?
Two numbers, half an hour, and you will know more about your cash position than most owners know about theirs.
One: your real debtor days. Take your debtors balance, divide by your annual sales, multiply by 365. If your terms are 30 days and the answer is 58, you are funding your customers for four extra weeks out of your own pocket.
Two: your months of cover. Take the cash in the account and divide it by one month of total operating costs. The accepted benchmark is three to six months. Between 15% and 27% of Australian SMEs hold almost none.
If your answer is under one month, that is your most urgent number, ahead of anything to do with growth.
Why growth makes this worse
This is the cruel part. The faster you grow, the worse your cash position gets, right at the moment everybody is congratulating you.
Every new job needs to be paid for before it pays you. More revenue means more stock, more wages, more debtors, all funded up front out of an account that has not yet received last month's money. Businesses do not usually run out of cash when things are bad. They run out when things are good and moving quickly.
Of the Australian businesses hit by cash flow pressure, 27% responded by using personal savings or skipping their own pay. That is the owner funding the growth personally, and it is far more common than anybody says out loud.
A thinner margin makes all of this worse, and margins have been thinning for six years.
[Sarah, a specific moment where your report and your bank account disagreed would be strong here. One month, one number.]
In conclusion
Profit is a calculation. Cash is a fact. You are judged on the first and you survive on the second.
The four gaps are debtors, stock, capital and principal, and tax you are holding.
Work out your real debtor days. If the answer is more than your terms plus a week, that is money you have earned and are not holding.
Work out your months of cover. Under one month means fix this before anything else.
Growth makes cash worse before it makes it better. Plan the cash before you chase the revenue.
If your reports say one thing and your bank account says another, a Business Analysis will tell you exactly where the gap is and what it is costing you.
Call me at 0491 729 043, or book a conversation at sarahcolgate.com.au.