It surprises people every time. The profit and loss says the business made $180,000. The bank account says there is $4,000 in it and the BAS is due.
Both are true. Profit and cash are different things, and the gap between them has five usual causes.
1. Your debtors are funding your customers
You invoice on 30 days. Your customers pay at 55. Your suppliers want 14. The difference is working capital, and it comes out of your bank account.
Growth makes this worse, not better. A business that doubles its sales doubles the amount of cash tied up in debtors, and it does that before any of the new revenue arrives. Fast growth is one of the most common causes of insolvency, and it is deeply counterintuitive to the person experiencing it.
What helps: invoice the day the work is done rather than at month end. Take a deposit. Make payment easy, because a business that only accepts bank transfer gets paid slower than one that accepts card. Follow up at day one past due, politely, every time, so that being chased is a normal part of dealing with you rather than an escalation.
2. Stock is cash sitting on a shelf
Every dollar of inventory is a dollar you have already paid for and not yet been paid for. Slow moving stock is worse than useless, because it consumed cash and it will probably be discounted eventually.
What helps: know your stock turn by category. The lines that turn slowly are where your cash is, and they are almost never the lines you would guess.
3. Tax is not an expense you can defer
GST collected is not your money. PAYG withheld is not your money. Both sit in your bank account looking like cash, which is exactly the problem.
Businesses that use GST and PAYG as working capital are extremely common and it works right up until it does not. With ATO interest now non-deductible, the cost of that approach has gone up materially.
What helps: a separate account. Move the GST and PAYG out on the day you receive them. It is a crude solution and it works better than any amount of discipline.
4. Drawings exceed profit
Owners of small companies and trusts often draw against the business through the year based on what feels affordable rather than what the numbers support. If drawings exceed available profits, the result is a loan account that has to be dealt with, and in a company that means Division 7A.
What helps: set a wage or a regular drawing, take it consistently, and review it quarterly against actual profit rather than adjusting it whenever the bank looks healthy.
5. Capital expenditure comes out of cash, not profit
A $60,000 vehicle affects your bank account by $60,000 and your profit by whatever the depreciation is. Loan principal repayments are the same. They leave the business and they never appear in the profit and loss.
What helps: look at the balance sheet, not just the profit and loss. Most business owners have never really read theirs, and the movement in it explains most of the gap between profit and cash.
The one thing to take away
Your profit and loss tells you whether the business model works. Your cash flow tells you whether the business survives long enough to prove it.
They answer different questions, and a business that only looks at one is flying with half the instruments.