Nine cash flow mistakes that make profit and cash disagree

Cash is the one thing in a set of books that cannot be argued with. Either the money is there or it is not. That is why cash flow errors are dangerous: they do not show up as a disagreement, they show up as a surprise.

The nine below are the ones that produce that surprise. Each is described with what causes it, what it hides, and what to do instead. Where a payment is regulated, the authority and the form are named.

What to take away

1. Reading profit as cash

A profitable period with less money in the bank than it started with, and nobody able to say why. The cause is working capital: profit is recorded when the sale is invoiced and when stock is bought, while cash moves when the customer pays and when the supplier is paid.

What it hides: the working capital movement. Sales invoiced but not collected, stock bought and not sold, and loan principal repaid, none of which appear in profit. Do instead: build the statement, following the method in the cash flow statement guide, and read the gap rather than guessing at it.

2. Treating a loan receipt as income

Money arrives from a lender and lands in income because it arrived in the bank.

What it hides: a liability. The period looks like it traded well when it borrowed well. Do instead: a loan receipt is financing. Nothing about it touches the profit statement except the interest that follows.

3. Putting a repayment entirely in one place

The whole repayment treated as a cost, or the whole thing treated as financing.

What it hides: either the interest or the reduction in the debt. Do instead: split it. Interest is operating, principal is financing, and both come from the lender's own schedule rather than an estimate.

4. Forecasting from an average month

Twelve equal months built from a recent average, projected forward.

What it hides: every payment that does not happen monthly. Insurance, tax, an annual software renewal and a quarterly bill can between them account for a large share of a year's outgoings, and all of them vanish in an average. The divergence shows up in the month of the payment itself: cash leaves in one amount while the books recognize the cost over twelve months, so a month can report profit and a falling bank balance at the same time. Do instead: build the forecast from a list of known commitments with their actual dates, then add the variable items.

5. Spending money held for someone else

What it hides: that the balance is not the business's balance. Payroll tax withheld from employees is held in trust for the IRS and reported on Form 941 each quarter; sales tax collected is held for the state. Neither is income, neither is a cost, and both are owed whether or not the cash is still in the account. This is the error that turns a working business into an insolvent one, and it happens gradually.

Do instead: compute what is held on behalf of others at each period end and read the bank balance net of it. Some businesses move it to a separate account, which costs nothing and removes the temptation; the public guidance on opening a business bank account covers how those are usually set up.

6. Netting inflows against outflows

A settlement from a payment processor arriving net of fees and refunds, recorded as one line.

What it hides: the fee, which is a cost, and the refunds, which reverse sales. Record only the net deposit and the fee and refunds never appear as costs, so profit is overstated by exactly the amounts the bank never received, and the business never sees what its payment costs are. Do instead: decompose the settlement from the processor's own report — Stripe, Square and PayPal each publish one for every payout — and record the gross receipt, the fee and the refunds separately.

7. Forgetting that payroll has a rhythm of its own

A forecast built on twelve equal payroll months when the calendar produces an occasional extra pay date, or when a tax payment falls quarterly.

What it hides: a month with more payroll outgoings than any model expected. Do instead: put actual pay dates on a calendar for the year ahead and read the outgoings from that. Payroll tax runs on its own calendar, which has nothing to do with the profit and loss account: federal income tax and Social Security and Medicare withheld from wages are reported to the IRS on Form 941 each quarter, federal unemployment on Form 940 annually, and state unemployment to the state agency. The same applies to any obligation with its own timetable, and the IRS guidance on paying business taxes and your state revenue department's registration pages set out where to find the ones that apply to you.

8. Mixing the sections

Equipment bought on finance appearing wholly in investing, or drawings appearing in operating.

What it hides: the shape of the statement, which is most of its meaning. Mixing the sections does not change the cash, but it removes the explanation of the gap: money from lenders and owners lands in operating and the statement appears to show trading generating cash that it did not. A business whose operating line looks healthy because owner drawings were classified elsewhere is reading a statement about a different business. Do instead: put every movement through the three-box test. Trading, things kept, or money from lenders and owners.

9. Assuming the aged report is a forecast

Treating everything owed as though it will arrive on its due date.

What it hides: the customers who are consistently late and the invoice that is quietly disputed. Profit records the sale on the invoice date and cash arrives later, or never, and the aged report cannot tell those two apart. Assuming everything owed will arrive on its due date therefore assumes away the commonest reason profit and cash disagree. Do instead: forecast collections from what each customer has actually done, not from terms. The process for finding out which is which is in the accounts receivable guide.

The two checks worth building in

Both take minutes. The second is the one that people find uncomfortable and the one that changes behavior, because it converts a comfortable balance into the smaller number that is actually available.

Common questions