– How can my business show a profit yet there’s no additional cash?
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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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