Profit versus Cash

     Many entrepreneurs are disappointed when they learn that even though their income statement is rosy, they are still consistently short of cash. Cash, not profit, is the life-blood of a business in its early stages, because if you can't pay your bills, you will eventually go out of business.  If your income statement looks healthy, but your cash situation is dismal, consider these variables:

Increases in inventory

     Increases in inventory do not immediately affect your income statement.  You may make a large inventory purchase one month, and pay cash for it, but this inventory purchase will not impact your income statement until it is sold, and then it appears as a cost of goods sold expense.

Customer purchases on credit

     Every time a customer makes a purchase on credit an accounts receivable is created.  This purchase is shown on the income statement as revenue, but no cash is received from the customer until a later period, maybe one to two months after the sale.  You can see how a small business can quickly become strapped for cash if there is a long time between when their inventory is purchased and when they actually receive cash from their customers.

Large loan payments

     This is another situation where a cash outflow does not appear on the income statement. Loan payments usually consist of an interest component and a principal repayment component.  For example, a monthly loan payment of $1,000 may consist of $100 interest and $900 principal repayment. Because the principal repayment portion is merely repaying money given to you earlier, it does not appear on the income statement as an expense.  The interest portion, however, is a legitimate expense and does appear on the income statement.  Thus, if you are making large principal repayments, it is possible for you to be short of cash, even though your income statement shows a profit.

Unprofitable, but cash rich

     It is also possible for you to be cash rich even though your income statement looks dismal. This can arise when you have a large depreciation expense on your income statement.  Since depreciation expense is a non-cash expense (no cheque is written for this expense), you may have cash to spend even though your large depreciation expense makes your business appear unprofitable.