Why profit and cash flow differ
Profit is calculated on an accruals basis. Revenue is recognised when a sale is made, and costs are recognised when they are incurred, regardless of when cash actually changes hands. A business can report a profitable month in which it raised £100,000 of invoices but received no cash payments.
Cash flow reflects actual money received and paid. Until an invoice is paid, that revenue does not appear in cash flow. Until a supplier invoice is settled, that cost does not appear in cash paid.
The timing difference
The gap between recognising profit and receiving cash is driven primarily by payment terms. A business with 60-day debtor days will receive its January revenue in March. In a growing business, this gap compounds: each month of growth adds more outstanding invoices to the ledger before the previous month's invoices have been collected.
- Invoice raised in January, recognised as revenue immediately
- Customer pays in March, cash received two months later
- In a growing business, each month adds more to the gap
- Working capital requirement grows faster than profitability
The invoice finance solution
Invoice finance is specifically designed to bridge the gap between profit and cash flow. By advancing funds against invoices as soon as they are raised, invoice finance converts accruals-based profit into actual cash, enabling the business to invest in growth rather than waiting for customers to pay.
Frequently Asked Questions
Can a company be profitable and go bust?
Yes. This is known as insolvency due to cash flow rather than balance sheet insolvency. A company that cannot pay its debts as they fall due is technically insolvent even if its assets exceed its liabilities on paper.