In the last article, I wrote about that moment when you have a good month. When things feel like they are working and decisions are easier.
On reflection, I think I could have explained this better. I’m going with a picture tells a thousand words. Below is a chart I have mocked up, to try and make things clearer.
Starting from the left, you have your cash in the bank at the beginning of the month.
The month happens, and you make a profit. So far, so good. (Here’s where it can break.)
Then something else happens that lowers your cash balance. Not because anything is wrong, but because of timing:
- Customers haven’t paid yet
- Quarterly tax payments fall due
- Supplier costs go out
- Things don’t line up perfectly
So even though you made a profit during the month, you can end up with less cash than you started with.
Profit does not equal cash.
Update: Leah Cunningham sent in the chart below after reading this article. Leah felt it showed the difference between what founders and CEOs expect, and what actually happens, more clearly than my original. I think she is right. Thanks Leah.
Communicating the difference
When I first started working through the difference between profit and cash with founders and CEOs, I tried to explain it using cash flow statements.
I ended up creating more confusion than clarity about how cash actually moves.
So I had to make it simpler. Something founders and CEOs can use while they are running the business and making decisions. Now I think about cash movement in a much simpler way.
Cash doesn’t move for one reason.
It moves because of two things that are happening all the time:
- how the business is performing (profit or loss)
- when money actually moves (timing and working capital)
There is a third element, but it tends to happen in chunks:
- decisions about financing or assets (capital flows)
I haven’t included the third element in the chart above because it doesn’t happen every month.
Putting it together:
Cash movement = Profit ± Working Capital ± Capital Flows
The important thing to remember is that these three move separately.
You need to understand each of them, and then bring them together, to see what is really happening to your cash.
I hope this helps.
