I've made a healthy profit - but where's the cash? (2024)

This is an incredibly common query that we get from businesses when we first start working with them - their financial statements show a well-performing business with a healthy profit at the end of the year, but there’s little in the way of cash on hand.

It’s natural to wonder where all that cash went - but rest assured it didn’t disappear into thin air. In this article, we’ll aim to provide some more clarity over this age-old question.

The difference between profit and cash

Before going further, it’s important to differentiate between profit and cash (or ‘cash on hand’). Fundamentally profit refers to the business income less the expenses incurred. These expenses can reflect overheads, cost of goods sold, advertising costs, transport, etc - really anything that costs money required for your business to operate.

Cash on the other hand refers to the liquidity of your business, in terms of the money in your bank account, which you can use to spend on things like bills, expenses, loan repayments, employee payroll etc.

It’s fairly normal for a small Kiwi business to have modest to low cash on hand after they’ve paid their expenses, and paid themselves, too. While it’s not a rule that you need a large business account, a cash buffer protects you and your business from unexpected events and one off costs that come up. More on that later…

Aged receivables

A really common reason for showing profit for a time period but low or no cash on hand is due to the gap between sending invoices to customers and actually getting paid. Unfortunately, slow payment is rife in New Zealand and it’s common for businesses to have aged receivables on their financial statements at any given time. It’s important to keep on top of customers who are frequently late with paying - businesses must set their own standards with regard to paying on time.

Depending on the accounting method you’re using, the sales you make, less expenses, may show a healthy profit, whereas, in reality, your account doesn’t look as healthy as it might, because your cash flow is slow. A slow cash flow also prevents you from making decisions around spending on the business.

Your drawings from the business

Drawings from a small business are those funds taken from the business bank account and used for personal costs - mortgage, petrol, groceries, kids' sports equipment - you name it. As personal costs are not business related and not deductible, they are shown through the shareholder current account, not the profit & loss. Therefore, the business can have a profit and loss statement that looks very healthy while simultaneously having a bank account that is low on cash.

Because you can take drawings out at your discretion, it is normal for self-employed business owners to pull out more on good months and less on quieter months. If this works for you then that’s great, however, it may be worth setting a minimum amount of income/cash that’s left ‘inside’ the business each month which can be used to build up your level of cash reserves should your business need it.

Your spending habits in the business

Putting aside personal drawings for a moment, how the business spends money can impact the cash flow considerably, even whilst maintaining a healthy profit margin. This has less to do with the amounts spent than it does with the timing of the spending. You may encounter situations where you spend a considerable amount on products or services that are to be sold later on as profit-generating sales.

If your last profit & loss reporting was done at the end of a cycle e.g. you’ve invoiced out sales for products purchased/costs incurred in previous months and made payments for purchases ready for the next wave of sales, you may have a healthy profit number and low cash on hand. This is compounded by slow-paying customers as the sales are reflected in the profit and loss when invoices are issued, but the cash has not yet been received.

Loans

Cash flow can similarly be reduced by outgoings that are due in the time between invoicing your customers and receiving payment from them. A loan the business is servicing, might on the annual profit and loss report, still be part of a profit-generating business. Loan repayments are often made up of a principal portion and an interest portion. While the interest portion is generally deductible (and therefore represented on the profit and loss), the principal portion is not so as an example – the business may pay $2,000 interest and $8,000 principal towards a loan, but only the $2,000 interest portion will come off of the profit, whereas the full $10,000 is coming out of the businesses cash flow.

Payment of loan repayments and other costs like payroll, rent, transport, utilities etc deplete cash resources in the short-term leaving your cash position light even with expected cash flow in the future. If this falls into a cycle whereby the business is constantly catching up with payables and receivables, your cash on hand will rarely seem an accurate reflection of your business’ performance.

How’s your cash flow looking?

A frequent flow of cash empowers your business to be nimbler and make investment decisions at the right time. Having cash on hand at any given time is also important because it provides some protection from market forces, loss in business, or another unexpected event that reduces sales in the short term.

In order to build up a surplus of cash reserves, a business must first generate enough sales. Then, the expenses incurred by the business need to be closely managed and reduced where possible. Finally, the attention to chasing up late invoices and setting clear parameters around payment terms with customers will help mitigate your business from being in an exposed cash position.

Think carefully about how much time you afford customers to pay their bills - both officially and in practice. It’s much better to proactively manage this in the terms of engagement you have set with your customers, and through positive relationship building, than it is to impose penalties - even those clearly outlined in a contract with your customer.

Many business owners are concerned about scaring off customers from repeat business. Our argument here is that customers that consistently don’t pay are not worth keeping around and actually hurt your business long-term.

Why profit is still important (even if it doesn’t translate to cash on hand)

Profit reporting provides a good picture of the business’ performance to various sources that require this information. First and foremost, it is the Inland Revenue and your accountant who will use the information around income and expenses to tax your business accurately. But a growing business may look for investment or credit as part of a growth strategy. A healthy profit is one of the indicators those parties will be looking for when considering whether to get involved or not.

Running a profitable business, at its core, is about survival. Continual losses year over year need to be supplemented from somewhere, and eventually, those sources will stop, whether that’s from your personal funds or another investment source. You need to focus on generating a healthy profit, whilst ensuring your day-to-day operations enable fast cash flow, controlled outgoings, and the gradual build-up of cash to place the business in a stronger position.

Want more help understanding how your business's cash flow and profit is performing?

RightWay helps New Zealand businesses across the country to optimise and improve their business performance.

Our team of business advisors (who we call business partners) is made up of experienced business owners and managers who’ve gone through the trials and tribulations of business growth and can now impart their wisdom to you.

We understand how to get control over your business’s profit margin and where to identify opportunities for improvement that allow you to build up cash in your business account - as well as techniques for keeping a healthy flow of cash.

We also offer HR support, bookkeeping and payroll, and of course accounting services to our clients. You don’t have to hire these functions internally - simply chat to us about your needs and we can help build a plan that works for you.