‘I Made a Profit — Where’s the Cash?’
Originally published: 04.01.18 by Ruth King
A reader posed the question in the headline to me — and many of you may have the same question: Where’s the cash?
You look at the bottom line of your profit and loss statement (P&L) every month and see that your company has a profit.
You see profits month after month yet you run up against a cash crunch — payroll, or at this time of year, having to pay your taxes, can be a struggle.
You just don’t understand how your company can be profitable and you don’t have cash.
Here’s the answer: Profits are just that — profts. It means your revenues were greater than your expenses. A loss is where expenses are greater than revenue. Neither means you have cash. Profits are a P&L item; cash is a balance sheet item. The two are very different.
So, how do you get cash? Here is the detailed explanation:
A revenue/sale (P&L) turns into an accounts receivable (balance sheet) when you bill for the work you did. Then you must collect for the work you did (balance sheet). If you are COD, your accounts receivable instantly turns into cash (balance sheet).
When you get your vendor invoices you enter them as an expense (P&L) and create an accounts payable (balance sheet). Then you must pay your accounts payable (balance sheet) and hopefully you have cash left (balance sheet).
Most contractors experience months where your company showed a loss yet there is still cash in the bank.
The opposite is also true: There are times where your company shows a profit and you are having problems scraping enough cash together to pay payroll.
Warning: Even though your P&L shows a profit month after month, you can grow your company out of business.
This happens when you run out of cash and don’t have a line of credit or maintenance agreement savings to cover temporary cash shortages.
Here are five specific ways to go broke.
You do profitable work but collect for it months later or never collect for it … after you paid your employees and your suppliers.
Untimeliness or Inaccuracies
You don’t have timely, accurate financial statements to ensure your service, replacement and new construction jobs are sold at a profitable price.
Cash Instead of Accrual
You use the cash method instead of the accrual method of accounting. Cash method means that you record a sale when you get paid.
You record an expense when you pay the bill. There are no accounts receivable or accounts payable.
Accrual method means you record a sale when you send the customer a bill even if the customer has not paid yet. You record an expense when you receive an invoice from a vendor, even if you haven’t paid the bill. You have accounts receivable and accounts payable.
Cash method of accounting almost always shows a profit, whether or not your service work or replacement jobs are profitable since you generally don’t pay bills until you have cash to pay them.
You perform profitable work but the customer files bankruptcy during the middle of a project leaving your company with hundreds of thousands of dollars in receivables that are uncollectable.
Too Much Inventory
You purchase too much inventory, giving your employees total access to your warehouse and allowing them to keep too much on their trucks. You’re betting your hard earned cash that you can sell what you’ve bought. What does your warehouse look like?
Here’s a growth rule of thumb: You need 10 percent of your projected growth in cash to fund the growth. If your plan is to grow by $250,000 in a year, you need $25,000 in cash to fund that growth.
The cash is used for increased inventory, increased accounts receivable (if your company is not a COD company), increased overhead expenses, and potentially a vehicle or other fixed asset purchase.
Profits don’t pay the bills, however, profitable jobs are necessary to pay the bills. Collect for your profitable work quickly, pay your bills associated with that job, and stay solvent.