Profit versus cash
Most businesses keep their books on the accrual basis: you record a sale when you invoice it and an expense when you incur it. Profit on the income statement follows those rules. Cash follows a different rule: money counts only when it actually moves in or out of your account.
Tip
Read your cash flow statement alongside your P&L every month. The P&L tells you whether the business model works. The cash flow statement tells you whether you can pay next month’s bills.
Where the cash goes
- Unpaid invoices. Sales you’ve invoiced but not collected are profit, not cash.
- Inventory. Stock you’ve bought but not sold is an asset on the balance sheet. It hasn’t hit the P&L as an expense, but the cash is gone.
- Loan principal. Only the interest portion of a loan payment is an expense. The principal reduces cash without reducing profit.
- Equipment purchases. A $12,000 van is expensed gradually through depreciation, but you paid for it on day one.
- Owner draws. Money you take out of a sole proprietorship isn’t an expense, so profit stays the same while cash drops.
- Sales tax and payroll remittances. HST collected and source deductions sit in your account until they’re due. They’re not yours to spend.
A worked example
A Shopify seller reports $40,000 of profit for the year but ends the year with less cash than it started with.
| Item | Effect on cash |
|---|---|
| Net profit for the year | $40,000 |
| Add back depreciation (no cash spent) | $3,000 |
| Increase in inventory | −$18,000 |
| Increase in wholesale receivables | −$9,500 |
| New equipment purchased | −$12,000 |
| Loan principal repaid | −$6,000 |
| Owner draws | −$24,000 |
| Change in cash | −$26,500 |
Nothing here is wrong with the business model. The seller grew inventory, extended credit to wholesale customers and bought equipment, all while drawing a salary. Each is a reasonable decision. Together they used more cash than the business generated.
How to close the gap
- Forecast cash 13 weeks ahead and update it weekly.
- Invoice promptly, set clear payment terms, and follow up on overdue accounts.
- Order inventory against a sales forecast rather than supplier minimums alone.
- Finance long-lived equipment with term financing instead of operating cash.
- Move HST collected into a separate account as it comes in.
Try it
Use the Cash Flow Calculator to see how many months your current balance lasts at your current inflows and outflows.
Sources
- Worked example prepared by Ronidex.
- BDC: Manage your finances
This guide is general educational information, not personalized accounting or financial advice.