– How can my business show a profit yet there’s no additional cash?
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Depending on the business, you have money wrapped up in stuff.
As an example, let’s say you are a landscaping business. You start out invest $15,000 of your own money, or borrowing it. You buy a $10k truck and $5k in equipment and start cutting grass. You start making money and paying yourself, paying for some advertising, repaying your investment.
You’ve taken in at least $15k in revenue, let’s say you’ve taken in $20k in revenue. Some of that is eaten up in operating expenses (fuel), some of that went to paying yourself (salary) and some went to paying off the equipment.
Now you’re investor or loan has been repaid. The company has $0 in debt. It no longer has that $20k in cash from revenue, but now it has assets. Those assets can either continue to be used to make more revenue, or sold off. If liquidating the company assets is the direction you go, then you’ll your cash. Right now your cash is in stuff, wether it be equipment, inventory, investment, etc.
I meant to add some additional text to the question. I’m trying to understand cash flow stemming from my title of the post. I’m showing a profit for last two quarters, cash flow fluctuates a bit, but general seems stable. Considering there is a profit, but no real significance in cash in the bank, does this mean I have negative cash flow or positive? I’m this scenario should I spend money to reduce it?
Business is a continuous cycle, so while you may have profits you may have already committed that cash to new inventory. Also, there are non-cash considerations, like ways capital expenses get allocated over time. Maybe you bought a $50k delivery van this year, but then record the expense over the next 5 years.
Do you have an accountant? You need to talk to your accountant about what is going on. It seems that you don’t understand your financial situation and where your money is going and why, and this subreddit is not going to be able to help you with that.
When you’re comparing your net profit to your actual change in cash year over year, there are three main types of cash flows to consider:
1) *Operating Cash Flows*
Operating cash flows are equal to your net profit, plus (minus) any non-cash expenses (incomes), plus (minus) cash inflows (outflows) from changes in working capital items.
To put it in ELI5 terms, your operating cash flows can be seen as the *cash profit* of your business. If Net Profit = Revenues – Expenses, then Cash Profit = Cash Revenues – Cash Expenses.
Cash Revenues and Expenses are easy enough to figure out: take your Total Revenues and your Total Expenses, and subtract any non-cash items. This includes revenues that you’ve invoiced but not received cash for (or, increases in accounts receivable), expenses that you incurred but have yet to pay cash for (or, increases in accounts payable), depreciation (a non-cash expense), etc..
Basically, if your net profit is $1,000, having non-cash expenses means that your operating cash flows will be >$1,000, while non-cash revenues mean your operating cash flows will be <$1,000. This is an important metric to see if your business’ core operations are generating cash.
2) *Investing Cash Flows*
These cash flows are exactly what they sound like: investments in long-term assets that benefit your business. If you buy a truck, for example, that’s not an expense – I can get into the accounting rationale, but for now, just know that capital asset purchases (equipment, vehicles, real estate, etc.) aren’t expenses. They show up as Investing Cash Flows, where purchases of assets are cash outflows and sales of assets are cash inflows. There are other investing cash flows, but asset purchases/sales are the most common.
3) *Financing Cash Flows*
These cash flows relate to debt. If you take on a loan, you don’t report the cash you receive as revenue, you just add the loan to your balance sheet and increase your cash balances. The cash inflow shows up as a Financing Cash Flow on your cash flow statement, and payments towards that debt show up as cash outflows.
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Okay, so, you have these three sets of cash flows – what now? Well, if you want to figure out why your cash balances aren’t increasing despite you making money, look at your operating cash flows first: am I *actually* generating cash from my operations? If not, then it’s worth it to drill down deeper into items specifically impacting cash flow – is it taking too long for you to collect your receivables? Are you using cash for all of your expenses when you could be utilizing credit?
If your operating cash flows are positive and in line with your profits, then look at your investing and financing cash flows: am I spending a lot of money on new assets? Do I have high debt repayment that’s draining my cash? Can I finance some of the assets I’m buying to offset the cash outflows?
Once you’ve drilled down into the individual cash flow items, you can see where your cash is going – this will also help you to budget how much cash you need on hand. If your business is generating positive operating cash flow, then you only need to keep enough excess cash to cover your Investing and Financing cash flows, plus funds to cover any operational slowdowns.
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