Here’s a business mystery that can scare almost any business owner: Your Profit & Loss statement shows a profit, but your bank account doesn’t seem to have the money to prove it. Where did the cash go?
This is exactly what happened to a business owner who came to us looking for answers. His company was growing quickly, with revenue increasing from around $3 million to a projected $7 million. He even had his sights set on $10 million. The problem? Despite all that growth, he was worried about having enough cash to cover payroll. After reviewing several years of financial information, we discovered that the company had actually been more profitable when it was generating $3 million in revenue. So what was happening?
Following the Clues
One of the first red flags was pricing. The owner was proud that nearly every proposal the company submitted was accepted. While that sounds like good news, it can actually mean you're underpricing your services.
At the same time, payroll costs were taking up an increasing percentage of revenue. This suggested that the company wasn't operating as efficiently as it had in the past. Employees could be waiting on supplies, waiting for other parts of a project to be completed, or spending more time on jobs than expected.
There was another problem with change orders. Additional work was being performed, but approvals weren't always properly documented. When it came time to collect the additional charges, customers sometimes questioned or refused to pay them.
All of these issues were cutting into the company's profitability.
The Plot Twist: Profit Isn't Cash
The biggest misunderstanding, however, was the difference between profit and cash flow.
The business had several owners receiving monthly distributions. Those distributions reduced the cash in the bank, but they didn't reduce the company's profit because distributions are payments of equity, not business expenses. This is an important lesson for every business owner: A profitable business can still have cash-flow problems.
Your cash may be going toward loan payments, equipment, inventory, owner distributions, taxes, or other expenses that don't appear on the Profit & Loss statement as a reduction in profit. Customers may also owe you money that hasn't been collected yet.
How to Avoid Your Own Financial Horror Story
The good news is that you don't need a detective to solve the mystery. You need to understand where your money is coming from and where it's going. Start by reviewing your pricing to make sure you're covering labor and overhead. Keep an eye on labor costs and efficiency so you know whether your team is working as productively as possible.
Make sure change orders are approved and documented before additional work begins. This can help prevent you from doing work that becomes difficult to collect.
Most importantly, monitor your cash flow. Know when customer payments are expected, when bills are due, and when you'll need cash for payroll and taxes. It's also important to set aside money for taxes so that the bill doesn't come as a frightening surprise.
The Case Is Closed
The next time you look at your Profit & Loss statement and wonder, “If we're making money, where did it go?”, don't assume your business is haunted. Profit and cash are two different things. Your P&L tells you about profitability, while your balance sheet and cash-flow information can help explain what is happening with your cash.
Don't just look at your profit. Follow the money.
Understanding where your cash is going can help you avoid surprises, make better business decisions, and keep a manageable cash-flow issue from turning into a full-blown financial horror story.
The scariest thing isn't having a profitable business. It's having a profitable business and not knowing where the cash went.
