Profit vs cash flow: why a profitable business can run out of cash
Profit measures income less expenses for a period. Cash flow follows money received and paid. Understanding both helps explain why a growing business can still struggle to pay its bills.
A café with profit and a cash shortage
Consider a fictional café that earns £3,000 of sales in a month and records £2,400 of operating expenses. In this simplified example it makes £600 operating profit. Depreciation, interest and tax are omitted. But £900 of those sales are still unpaid at month end. Customers have paid only £2,100.
The café begins with £800 in cash, pays £2,400 of operating bills and buys £700 of equipment. Closing cash is £800 + £2,100 − £2,400 − £700 = −£200. A negative forecast balance signals a funding gap: the café cannot actually pay everything as planned unless it changes timing, raises cash or arranges funding.
Why the equipment purchase is different
Buying equipment uses cash immediately. Equipment expected to benefit more than one period is generally recorded as an asset, with its cost allocated over its useful life through depreciation rather than charged entirely as an operating expense on purchase. This example leaves depreciation out to isolate cash timing; a complete profit forecast would include it.
Three questions for a cash forecast
- When will customers pay? A sale on credit does not immediately increase the bank balance.
- When must suppliers, staff and lenders be paid? Include investment and debt repayments as well as operating bills.
- What buffer remains if receipts arrive late? Change collection assumptions before relying on the base forecast.
Borrowing fills a gap; it does not create sales
If the café draws £500 of credit with no immediate fee, its forecast closing cash becomes £300. Its debt also rises by £500. Borrowing is a financing inflow, not revenue or profit. Interest and repayment commitments need their own forecast.
Try it yourself
Reduce collected sales by a further £200. Closing cash before financing becomes −£400. Identify an action, its cash effect and its tradeoff before choosing it. Delaying equipment may preserve cash but restrict operations; borrowing adds obligations.
Test a cash decision in Decision Lab, then compare profit margins and working capital.
Accounting reference: IFRS Foundation: IAS 7 cash-flow classification. Explore all finance guides →