A profitable August with no money in the account. Where the cash actually went
Profit is measured when work is earned. Cash moves when someone pays. In a busy month those two calendars can be six weeks apart.
- Written by
- Ellen Marsh
- Published
- Filed under
- Corporate
- Length
- 908 words, about 4 minutes
August is the month this becomes obvious for seasonal businesses. The books show the best month of the year. The bank account is lower than it was in June, and payroll is Friday.
Nothing is wrong with either number. They are measuring different things on different calendars.
The two calendars
Profit is recorded when work is performed and costs are incurred, regardless of when money moves. Cash is recorded when money actually arrives or leaves.
In a slow month with steady customers the two look similar. In a fast-growing month they diverge sharply, and growth is the thing that causes the divergence. That is the part people find counterintuitive: the busier the month, the wider the gap.
Walking a busy month through both
| Event | Effect on profit | Effect on cash |
|---|---|---|
| Buy materials for four jobs | None yet, held as inventory or job cost | Immediate outflow |
| Pay the crew for the week | Recorded as the work is done | Immediate outflow |
| Complete a job and invoice it | Full revenue recorded now | Nothing yet |
| Customer pays thirty days later | None, already recorded | Inflow, next month |
| Buy a second van | Small, only the depreciation | Large outflow, or a loan payment |
| Remit sales tax collected in July | None, it was never revenue | Outflow |
| Pay quarterly estimated tax | None, it is a distribution of profit | Outflow |
Read down the two columns. Profit is driven by the third row. Cash is driven by every other row. A month that adds four jobs adds four rounds of materials and labor immediately and four receivables later.
The five things that consume cash in a good month
- Receivables growth. Every new customer on terms is an amount you have earned and not received. Growing the customer base grows this balance, and it does not come back until growth stops.
- Inventory and materials bought ahead. Buying at a discount for the season is a reasonable decision that converts cash into shelves.
- Payroll timing. Wages are paid on a fixed cycle regardless of when customers pay. Overtime in a peak month lands entirely inside the month it was worked.
- Money held for someone else. Sales tax collected and payroll tax withheld are not revenue at any point. They sit in the account looking like a balance and they belong to an agency with a due date.
- Capital purchases. A vehicle or a machine leaves the account at once and enters the profit calculation slowly.
Number four is the one that damages businesses. An account balance inflated by taxes collected on someone else's behalf reads as available cash, and spending it produces a shortfall exactly when the filing is due.
The three numbers to watch instead of the bank balance
- Days to get paid. Divide the receivables balance by average daily sales. This tells you how long your money spends with customers. Watch the direction it moves, not the absolute figure.
- The cash conversion gap. The days between paying for materials and labor and receiving payment for the job. This is the number of days of operating cash a business needs on hand, and it widens with volume.
- Free cash after obligations. Bank balance minus taxes held, minus this month's payroll, minus committed supplier payments. This is the only figure that represents money you can actually spend.
What actually closes the gap
Five interventions, in order of how quickly they work.
- Invoice on completion, the same day. The most common cause of slow payment is slow invoicing. Days lost here are days added directly to the gap.
- Take deposits. A deposit covering materials converts the largest upfront cost from your cash into the customer's. Standard in most trades and easy to introduce for new customers.
- Progress billing on longer jobs. Billing at defined stages rather than at the end keeps cash arriving through the work instead of after it.
- Separate the tax money. A second account, funded on the day the sale is made or payroll is run. This costs nothing and removes the largest single failure mode.
- Arrange the credit line before you need it. A facility applied for in a good month is available on better terms than one sought in a bad one. Use it for timing, not for losses.
The seasonal version of the problem
Businesses with a strong season have a predictable shape: cash builds through the peak, then falls through the off season while fixed costs continue. The failure usually happens in the trough, and it is caused by decisions made at the top.
Two habits that hold it together. Forecast thirteen weeks ahead by week, listing expected receipts and known payments, and update it every Monday. It takes twenty minutes and it is the single most useful management document a small business produces. And decide in the peak what portion of the surplus is reserved for the off season, before it is available to spend.
Guidance on small business financial management, including planning and lending programs, is published by the Small Business Administration, and the planning templates there are a reasonable starting point for a first forecast.
What the profitable August actually meant
It meant the work was priced correctly and performed profitably, which is the harder problem and the one that was solved. The cash position was a timing question with known causes and known fixes.
Businesses that fail while profitable almost always failed on timing, and timing is the part that a weekly forecast and a separate tax account largely eliminate.