Profitable Business but No Cash? Here’s Where the Money Goes

A profitable business but no cash in the bank can be a particularly frustrating situation for a limited company director. The accounts show that you are making money, sales are increasing and customers seem happy. Yet the bank balance never quite reflects that success.here...

You may even find yourself worrying about the next VAT payment or whether there is enough cash to cover salaries, despite having just been told that your company made a substantial profit.

Having worked in accountancy practice and senior finance roles in industry, I have seen businesses from both sides of the accounts. One thing that experience taught me is that a healthy profit and a healthy bank balance are not necessarily the same thing.

Profit tells you whether your business is making money. Cashflow tells you whether that money is available when you need it.

A business needs both.

A Company Made £120,000 Profit. So Why Did Its Cash Fall by £48,000?

Let’s take the example of Logan Ltd, a company selling specialist equipment to other businesses. The directors have worked hard over several years to build the business, and sales have been growing steadily.

At the end of the financial year, the accounts show a profit before tax of £120,000. On the face of it, that’s a good result, and the directors are understandably pleased. They might also expect to see a healthy bank balance to reflect that profit.

But when they look at the company’s bank account, the picture is rather different. The balance has fallen from £85,000 to just £37,000. That’s £48,000 less cash in the bank, despite the company making a substantial profit.

So where has the money gone?

To understand what’s happened, we need to look beyond the profit figure and see how the company’s cash has actually been used during the year.

This simplified example assumes there are no other cash movements, that the relevant VAT balances have not changed and that the Corporation Tax payment relates to the company's tax liabilities.

The company really has made £120,000 profit before tax. That figure isn't wrong. But some of that profit hasn't yet turned into cash, while other money has been used to buy equipment, repay borrowing, pay tax and distribute dividends to shareholders.

The accounts and the bank balance are simply telling different parts of the same story. And that doesn't necessarily mean the company is performing badly. Some of those cash outflows may reflect perfectly sensible business decisions.

What matters is whether the directors understood the effect those decisions would have on the company's cash position before making them.

More Sales, More Profit – So Why Is There Less Cash?

One of the most common reasons a profitable business runs short of cash is that customers haven't yet paid for the goods or services they've bought.

Let's say Logan sells £50,000 of equipment to a customer who has 60 days to pay. Assuming the sale has been completed, the £50,000 will appear in the company's accounts as income, even though the money won't arrive in its bank account for another two months.

In the meantime, Logan may already have paid its supplier, covered the delivery costs and paid the employees involved in fulfilling the order. The accounts show the sale and the profit it has generated, but the cash hasn't arrived.

Now imagine Logan wins several more large orders. Sales are growing, profits are improving and the directors decide to take on another employee to cope with the extra work. Everything appears to be going well.

But there's a problem. The more the company sells on credit, the more money it may have tied up in unpaid invoices.

In Downton's case, the amount owed by customers increased by £70,000 during the year. That's an additional £70,000 the company has earned but hasn't yet collected.

The business is growing, but its customers are effectively holding on to cash that Horizon needs to pay its own bills.

Are You Giving Your Customers Too Long to Pay?

There's nothing wrong with offering customers credit. In some industries, it's simply part of doing business. But it's worth considering whether the payment terms you're offering are putting unnecessary pressure on your cashflow.

If Downton pays its suppliers within 30 days but gives customers 60 or 90 days to pay, the company has to fund that gap. And as sales increase, the amount of cash needed to keep things running can grow surprisingly quickly.

I'd start by looking at how long customers actually take to pay, rather than just the payment terms shown on their invoices. Are some customers regularly paying late? Are overdue invoices being chased promptly? Could the company ask for deposits or payments in stages, particularly on larger orders?

These are relatively simple questions, but the answers can make a real difference.

Sometimes, improving cashflow isn't about winning more business. It's about getting paid for the work you've already done.

Why Growing Businesses Can Find Themselves Short of Cash

Most business owners see growth as a sign that things are going well, and quite rightly. But what isn't always obvious is just how much cash a growing business can need before the extra sales start bringing money in.

An e-commerce business might need to buy more stock to meet demand. A consultancy may have to recruit additional staff before starting a major contract. A manufacturer might need to invest in new equipment and materials to fulfil larger orders.

All of these can be perfectly sensible business decisions. The difficulty is that the money often has to be spent well before the business receives payment from its customers.

Take Logan Ltd, for example. During the year, its stock increased by £35,000. That means the company has more money tied up in products it hasn't yet sold

The stock still has value and appears as an asset in the accounts, rather than being treated as an immediate expense. But the cash used to buy it has already left the bank.

That's one of the challenges of growth. A business can be selling more, making more profit and still find itself with less cash available to meet its day-to-day expenses.

How Much Cash Is Tied Up in Stock You Don't Need?

Having worked in industry, I've seen how easily stock levels can creep up without anyone really questioning whether the business needs to hold quite so much.

Perhaps a supplier offers a better price for ordering larger quantities. Perhaps the directors are worried about running out of popular products. Or perhaps sales haven't quite lived up to expectations.

There may be perfectly good reasons for holding additional stock. But every pound spent on products sitting in a warehouse is a pound that isn't available to pay wages, suppliers or other day-to-day expenses.

I'd want to look at which products are selling regularly, which have been sitting on the shelves for months and whether purchasing decisions are based on realistic sales forecasts.

Of course, the answer isn't simply to buy less. Running out of products that customers want can be just as damaging, particularly if it means losing sales.

The aim is to have enough stock to meet customer demand without tying up more of the company's cash than necessary.

Why Loan Repayments Can Leave a Profitable Business Short of Cash

Loan repayments are another reason a company can make a healthy profit but still see its bank balance falling.

Take Logan Ltd, for example. During the year, the company repaid £18,000 of its business loan. That money has left the bank, but because it's repayment of the original borrowing, it doesn't appear as an expense in the profit and loss account. Instead, it reduces the amount the company owes.

Interest is treated differently. Interest charged on the loan will generally be included as an expense in the accounts, reducing the company's profit

So while Logan's accounts show a profit of £120,000, the £18,000 capital repayment has reduced the cash available to the business without reducing that profit.

Borrowing can be a perfectly sensible way to finance growth or purchase equipment. But the repayments still need to be affordable, particularly when customers are taking longer to pay or the company is investing in additional stock.

I'd be especially interested in looking at businesses with several loans or finance agreements. Individually, the repayments may seem manageable, but together they can place considerable pressure on cashflow.

The important question isn't simply whether the business can afford to borrow, but whether it can comfortably afford the repayments.

Why Buying Equipment Can Leave Less Cash in the Bank

Buying new equipment can be a sensible investment, particularly if it helps a business increase production, improve efficiency or take on more work. But it's another example of how spending money doesn't always have an immediate effect on profit.

During the year, Logan spent £30,000 on equipment. In the accounts, that equipment is normally treated as a fixed asset, with its cost spread over its expected useful life through depreciation.

The bank account tells a different story. If Logan paid for the equipment outright, the full £30,000 would have left the bank when it was purchased.

In our example, Logan's £120,000 profit already includes a depreciation charge of £12,000. Because depreciation is an accounting expense rather than a cash payment, we add it back when working out what happened to the company's cash. We then deduct the £30,000 actually spent on equipment.

There's nothing necessarily wrong with this. The new equipment may help Logan generate considerably more income in future years. But the directors still need to make sure the company has enough cash to fund the purchase without putting pressure on its day-to-day finances.

It's also worth remembering that the tax relief available on equipment purchases doesn't necessarily follow the depreciation shown in the accounts. The timing and amount of relief will depend on the nature of the expenditure and the capital allowances available.

Why Tax Bills Can Catch Out Profitable Businesses

It's easy to concentrate on sales and profits when a business is doing well, but tax bills still need to be paid, regardless of how much cash is available in the bank.

Corporation Tax is calculated on taxable profits, which aren't necessarily the same as the profit shown in the accounts. And just because a company has made a healthy profit doesn't mean it has the cash available to pay the tax.

In Logan's case, the company paid £22,000 in Corporation Tax during the year. That's £22,000 less in the bank, even though the payment doesn't reduce the £120,000 profit before tax shown in our example.

VAT can present another challenge. When a VAT-registered business charges VAT to its customers, that money isn't additional income it can keep. After deducting any recoverable VAT on purchases, the balance may need to be paid to HMRC.

For businesses using standard VAT accounting, there's an added complication. VAT can become payable before the customer has actually paid the invoice. The VAT Cash Accounting Scheme can help eligible businesses with this timing difference, but it won't suit everyone.

The important point is that not all the money sitting in a company's bank account is available to spend. Some of it may already be needed to meet future tax liabilities.

Can Your Company Really Afford to Pay Dividends?

Dividends are another reason a profitable company can find itself with less cash in the bank.

During the year, Logan paid £25,000 in dividends to its shareholders. Unlike salaries, dividends aren't a business expense and don't reduce the profit shown in the company's profit and loss account. But the £25,000 has still left the bank.

This is particularly relevant to owner-managed limited companies, where directors often take a relatively modest salary and receive the rest of their income through dividends

Under the Companies Act 2006, a company can only pay dividends out of profits available for distribution. But having enough profits to pay a dividend doesn't necessarily mean there's enough cash available to do so comfortably.

For example, a company might have substantial retained profits, but much of its money could be tied up in unpaid customer invoices, stock or equipment. Paying a large dividend could then leave it struggling to meet its Corporation Tax bill, supplier payments or other commitments.

That's why I'd always want to look at both the profits available for distribution and the company's cash position before recommending a substantial dividend.

Just because a company has enough profits to pay a dividend doesn't mean it's sensible to take the money out.

Why a Healthy Bank Balance Doesn't Always Mean a Healthy Business

It's easy to look at the company bank account and assume that a healthy balance means the business is doing well. I can understand why, particularly when online banking and accounting software make it so easy to check the figures.

But the amount sitting in the bank doesn't always tell you very much about the company's overall financial position.

For example, one company might have £150,000 in the bank but also have substantial Corporation Tax and VAT bills to pay, along with outstanding supplier invoices and loan repayments.

Another might have just £30,000 in the bank but be expecting £200,000 from customers over the next couple of weeks. Assuming those customers pay on time, its cash position could look very different quite quickly.

Neither bank balance tells the whole story.

When I'm reviewing a company's finances, I'd want to look at much more than the money in the bank. How much do customers owe? What needs to be paid to suppliers and HMRC? How much cash is tied up in stock? Are there loan repayments or other significant commitments coming up?

This is where the balance sheet becomes particularly useful. Rather than treating it as something prepared once a year for the accounts, it can help directors understand where the company's money is tied up, what it owes and how financially secure the business really is.

Three Financial Reports Every Business Owner Should Understand

You don't need a finance department producing a 40-page report every month to understand how your business is performing. In fact, I'd probably question whether anyone was finding the time to read all 40 pages.

For many smaller limited companies, three straightforward, reliable reports can tell directors most of what they need to know about profitability, financial stability and cashflow.

Is the Business Actually Making Money?

A reliable profit and loss account shows whether the business is generating enough income to cover its costs and make a profit.

But I wouldn't just look at the final profit figure. I'd want to understand what's happening to gross profit margins, whether overheads are increasing and how the results compare with previous months.

For example, if sales are growing but profit margins are falling, the business could be working considerably harder without seeing much improvement in its financial results.

The important thing is to understand not just how much profit the company is making, but what's driving that profit and whether it's sustainable.

Where Is the Company's Money Tied Up?

An up-to-date balance sheet helps explain what the company owns, what it owes and where its money is tied up.

I'd pay particular attention to outstanding customer invoices, stock, amounts owed to suppliers, tax liabilities, borrowing and directors' loan accounts.

However, a balance sheet is only as useful as the information behind it. If bank accounts haven't been reconciled, old customer invoices are unlikely to be paid or stock is worth less than the amount recorded, the figures could give directors a misleading impression of the company's financial position.

That's why keeping the accounting records accurate and up to date matters. Otherwise, decisions may be based on figures that don't reflect what's really happening in the business.

Will There Be Enough Cash to Pay the Bills?

This is where a cashflow forecast becomes particularly valuable.

A forecast looks at when money is expected to come into the business and when payments will need to be made. It helps directors see potential cash shortages before they become a problem.

For many smaller companies, a rolling 13-week cashflow forecast is a good starting point. It's detailed enough to highlight upcoming pressures without trying to predict exactly what might happen several years into the future.

Longer-term forecasts certainly have their place, particularly when planning expansion or major investment. But in the short term, directors need to know whether there will be enough cash to pay staff, suppliers, HMRC and other commitments as they fall due.

And a forecast needs to be kept up to date. If a customer who was expected to pay on Friday now says the money won't arrive for another three weeks, that change needs to be reflected.

Otherwise, you're not really working with a forecast. You're working with a spreadsheet full of last month's expectations.

When Should You Start Worrying About Your Company's Cashflow?

Not every reduction in cash is a cause for concern. A company might deliberately use some of its reserves to buy new equipment, repay expensive borrowing or invest in expansion. Those decisions can make good commercial sense and strengthen the business over time.

What would concern me is a company that regularly struggles to pay its suppliers, uses money set aside for tax bills to cover everyday expenses or becomes increasingly dependent on borrowing just to keep things running.

I'd also want to understand why directors are repeatedly putting their own money into the company. Occasionally providing additional funding isn't necessarily a problem, but if it becomes a regular occurrence, something needs looking at more closely.

The first question I'd ask is whether the business has a timing problem or a more fundamental profitability problem.

For example, a profitable company might be short of cash because its customers take too long to pay. Improving credit control or changing payment terms could make a considerable difference.

But if the company is struggling because its prices are too low, its overheads are too high or it simply isn't making enough profit, chasing customers for payment won't solve the underlying problem.

These are very different situations, and understanding what's causing the cash shortage is essential before deciding what to do about it.

There is also a point where cashflow difficulties become more serious. If a company cannot pay its debts as they fall due, directors need to consider their legal responsibilities and seek appropriate professional advice promptly.

Where insolvency is a concern, directors must give proper consideration to creditors' interests. Continuing to trade without addressing the company's financial position can expose directors to significant risks.

Can Better Accounting Software Improve Your Cashflow?

I've always enjoyed working with technology, and I've spent a considerable part of my career implementing financial systems and finding better ways for businesses to manage their finances.

Good accounting software can make a real difference. It can help directors see which customers haven't paid, keep track of spending, monitor upcoming bills and understand how the business is performing without waiting until the year-end accounts are prepared.

But there's something I've learnt over the years: even the best software is only as good as the information going into it.

A dashboard might look impressive, but if it contains duplicate invoices, unreconciled bank transactions or stock figures that haven't been checked for months, the reports could be giving directors a completely misleading picture.

I've always believed that financial systems should make running a business easier, not create more work for everyone involved.

Sometimes that means investing in better software. Sometimes it's about getting existing systems to work together properly, so information doesn't have to be entered several times. And quite often, it's simply a case of making sure someone regularly reviews the figures and understands what they're telling them.

The aim isn't to produce more reports or introduce complicated processes. It's to give directors reliable, up-to-date information they can actually use to make better decisions about their business.

What Can Directors Do When Profits Are Up but Cash Is Running Low?

The first thing I'd want to understand is where the money has actually gone. That means comparing the company's profit with the movement in its bank balance, just as we've done with Logan.

This helps us identify whether cash has been tied up in unpaid customer invoices, additional stock or equipment, or used to repay borrowing, pay tax or distribute dividends.

Once we know what's happened, we can start looking at what needs to change.

In Logan's case, I'd be particularly interested in the £70,000 increase in money owed by customers and the additional £35,000 tied up in stock. Together, those two movements have absorbed £105,000 of cash.

The equipment purchase and loan repayments may have been sensible, planned decisions. The Corporation Tax payment may simply have been a liability that needed settling. But I'd want to understand why so much additional cash was tied up in customers and stock.

Are customers taking longer to pay? Has Logan started offering more generous credit terms? Is stock increasing faster than sales? Could changes to purchasing, invoicing or credit control help release some of that cash?

I'd also want to see a short-term cashflow forecast, ideally covering the next 13 weeks, to understand whether the company can comfortably meet its upcoming commitments.

After all, telling directors to increase profits isn't particularly helpful if the real problem is that the profits they're already making haven't yet turned into cash.

Profit Matters, but Cashflow Keeps a Business Running

Having spent much of my career working within businesses, I've learnt that financial figures are only really useful when you understand the commercial decisions behind them.

A growing business may need to invest more money in stock, staff or other resources before it sees the benefit of increased sales. Buying equipment might reduce cash today but improve efficiency and profitability in the years ahead. And repaying borrowing can strengthen the company's financial position, even if it leaves less money in the bank in the short term.

None of these decisions is necessarily a problem. In fact, they may be exactly what the business needs to do.

The aim isn't to keep as much money in the bank as possible. It's to understand how much cash the company needs, when that money will be needed and whether its plans are affordable.

For limited company directors, that means looking beyond the annual profit figure and taking a more active interest in the balance sheet, cashflow and the financial commitments coming up.

Good financial management doesn't have to involve complicated reports or endless spreadsheets. But it does mean understanding what's happening to the company's money and making decisions early enough to do something about it.

A profitable business is a good starting point. Making sure it has the cash to support its plans is just as important.

Making a Profit but Still Worried About Cashflow?

If your company is making a profit but you're not seeing that reflected in its bank balance, it may be time to take a closer look at the figures.

At The Friendly Accountants, we work with owner-managed limited companies to help directors understand what's happening behind the numbers, identify where cash may be tied up and make more informed financial decisions.

Whether you're concerned about cashflow, planning to grow your business or simply want a clearer picture of its financial position, we'd be happy to discuss how we can help. Give us a call on 01202 048696 or email us at [email protected] or [email protected].

Alternatively, please feel free to complete our Business Questionnaire here to tell us about your company and how we may be able to help.