It is one of the most common and least comfortable moments for an owner: the income statement shows a good quarter, and the bank account says otherwise. Nothing is necessarily wrong. Profit measures what the business earned; cash measures what it has. The distance between them has specific causes, and once they are named, the conversation about what to do next gets much easier.
A quarter that earned money and lost cash
Take an illustrative business, keeping accrual-basis books, that reports $120,000 of profit for the quarter. Over the same three months, customers come to owe it $70,000 more than before, it buys $40,000 more inventory than it sells, it pays $25,000 of loan principal, which is not an expense, and the owners take $30,000 in draws. With no other changes, such as in what it owes its suppliers, the quarter shows $120,000 of profit, and the bank balance falls by $45,000. The figures reconcile; profit and cash are measuring different things.
Growing businesses feel this most. More sales usually mean more receivables and more inventory before the cash arrives, so a company can become more profitable and shorter of cash in the same year.
- Net income for the period
- −More billed than collected: receivables grew.
- −More inventory bought than sold, or deposits paid ahead.
- +More bills recorded than paid: payables grew.
- +Depreciation and other non-cash expenses, which reduce profit but not cash.
- −Loan principal repaid, which is not an expense.
- −Equipment and other capital purchases, expensed over time.
- −Owner draws and distributions.
- =Change in cash for the period
Simplified; each sign shows the usual direction of the item. A monthly bridge ties every line to a reconciled account.
Where to look
Receivables, inventory, customer deposits, loan principal, equipment purchases and owner distributions explain most of the gap. Tax timing adds its own layer. Under the cash method, income generally counts when received and expenses when paid; under an accrual method, they count when earned or incurred. Taxable income and cash can drift apart in either direction, and payroll taxes and estimated payments keep a calendar of their own.
What a monthly close adds
Our monthly close ties the income statement to reconciled bank and card accounts and to aging for receivables and payables, so the gap is visible every month instead of discovered when a payment is due. With the causes in view, the owner can decide what to act on, whether that is collections, inventory purchasing, or the timing of a loan payment or a distribution.
Sources
Talk to us about the gap.
Tell us about the business and what the numbers are showing. We can talk through where the cash is going and how monthly reporting could help.
Contact our team