Cash Flow vs. Profit: Why Profitable Businesses Still Fail
"But Rod, we're profitable! How can we be running out of money?"
I hear this at least once a month. A business owner staring at their P&L statement showing a healthy profit, confused about why their bank account tells a different story.
The answer is simple but counterintuitive: profit and cash flow are not the same thing.
Understanding this difference isn't just accounting theory. It's the difference between business success and unexpected failure. Let me show you why.
What Is Profit?
Profit is what's left after you subtract expenses from revenue in a given period. Your accountant calculates it according to Generally Accepted Accounting Principles (GAAP). It appears on your Profit & Loss statement.
Here's the catch: profit is measured when revenue is earned and expenses are incurred, not when cash actually changes hands.
What Is Cash Flow?
Cash flow is exactly what it sounds like: the actual movement of money in and out of your business. It's what shows up (or doesn't show up) in your bank account.
You can't pay your employees with "accounts receivable." You can't pay your suppliers with "accrued revenue." You need actual cash.
A Real-World Example
Let me walk you through a scenario I see constantly in my fractional CFO practice:
January: You deliver $50,000 worth of services to a client. You invoice them with Net 30 terms.
Your January P&L shows:
Revenue: $50,000
Expenses: $30,000 (payroll, rent, materials you paid for immediately)
Profit: $20,000
Looks great, right?
Your January cash flow shows:
Cash in: $0 (customer hasn't paid yet)
Cash out: $30,000 (you paid everything immediately)
Net cash flow: -$30,000
You're $20,000 profitable but $30,000 poorer in actual cash.
February: The customer pays their invoice. Now you have the cash, but on your P&L, this doesn't show up as February revenue - it already counted in January.
Why This Matters More Than You Think
This timing difference creates four dangerous scenarios:
1. The Growth Trap
Rapidly growing businesses often fail despite increasing profits. Why? Every new sale requires you to spend cash upfront (materials, labor, overhead) before the customer pays you.
The faster you grow, the more cash you need. I've seen Okanagan businesses land their biggest contracts ever and nearly go bankrupt fulfilling them.
2. The Seasonal Squeeze
If you run a seasonal business, you might be profitable over the full year but run out of cash during slow months. Your annual P&L looks fine, but Week 23 was a crisis.
3. The Equipment Purchase
You buy a $100,000 piece of equipment. Your cash account drops $100,000 immediately. But on your P&L? You might only show $20,000 in depreciation expense this year. Your profit barely changes, but your cash position is devastated.
4. The Loan Payment Problem
You make a $5,000 loan payment. Principal portion: $4,000. Interest portion: $1,000.
Only the $1,000 interest shows up as an expense on your P&L. The $4,000 principal repayment? Not an expense, just a balance sheet transaction. But it's $4,000 that left your bank account.
The Hidden Killers of Cash Flow
Beyond the timing issues, several factors drain cash without touching your profit:
Inventory buildup: You bought $50,000 in inventory. It's an asset, not an expense. Doesn't hurt your profit. Definitely drains your cash.
Slow-paying customers: Net 30 terms become Net 60 reality. Your revenue is recognized, your profit looks good, but you're chasing payments to keep the lights on.
Owner draws or dividends: Taking money out of the business doesn't show up as an expense. Your profit stays the same, your cash disappears.
Fast-paying suppliers: You pay suppliers in 10 days to get a discount, but customers pay you in 45 days. Smart for margins, brutal for cash.
How to Manage Both
You need to watch both metrics, but watch them differently:
Track profit for: Overall business health, pricing decisions, long-term sustainability, tax planning, valuation.
Track cash flow for: Survival, paying bills, making payroll, timing major purchases, knowing when to borrow.
The businesses that thrive do three things:
1. Forecast cash religiously: Know what's coming in and going out for the next 13 weeks. Every week. Without fail.
2. Manage the timing gap: Negotiate better payment terms with customers. Extend payment terms with suppliers where it doesn't cost you. Arrange lines of credit before you need them.
3. Maintain cash reserves: The general rule is 3-6 months of operating expenses. Sounds like a lot, but it's what keeps you alive when a major customer pays late or a big opportunity requires upfront investment.
The Question You Should Ask
Don't ask: "Are we profitable?"
Ask: "Are we profitable AND do we have the cash to support our operations and growth?"
Both matter. But in the short term, cash flow is survival.
What This Means for Your Business
If you're only looking at your P&L, you're missing half the picture. You might be profitable right up until the moment you can't make payroll.
In my fractional CFO work, I help businesses in the $500K-$2.5M range navigate exactly this challenge. We build cash flow forecasts, identify the gaps, and create strategies to bridge them before they become crises.
Because being profitable matters. But staying liquid matters more.
Questions about your cash flow situation? Let's talk. Book a free 30-minute consultation and we'll review your specific challenges.