We made a profit, so where has all the cash gone?

You’ve received your year-end accounts, and the business has made a healthy profit. You know the business has had a good year, the team has been busy and there’s plenty of work going on.

But then you look at the bank account and wonder where all that profit has actually gone.

It’s a question we hear quite often from consultancy business owners. If the accounts say the business has made £100,000 profit, it’s perfectly reasonable to wonder why there isn’t another £100,000 sitting in the bank.

Profit and cash are two very different things. A business can be profitable and still feel quite tight for cash, particularly when it’s growing. Understanding why comes down to looking at how that profit turns into cash and where the cash is being used within the business.

Profit and cash aren't the same thing

Profit is more of an accounting measure. When we’re preparing a set of accounts, we’re looking at the income the business has earned and the costs it has incurred during a particular period. That doesn’t necessarily match when the money physically arrives in or leaves your bank account.

For example, imagine you complete a piece of work and raise an invoice for £50,000 at the end of the month. That £50,000 will be reflected in your accounts as income, but your client may be on 30, 60 or even 90-day payment terms.

Meaning the income is already showing in your accounts, but you haven’t actually got the cash yet.

For consultancy businesses, there can be quite a few stages between doing the work and having the money sitting in the bank.

You’ve done the work, but you haven’t billed it yet

Work in progress can tie up quite a lot of cash in a consultancy business.

Your team may have spent the whole month working on a project, but perhaps you can only invoice when you reach an agreed milestone. Or there may be additional work or variations that still need to be agreed with the client before you can raise an invoice.

You’ve already incurred the cost of delivering that work. Your employees still need to be paid at the end of the month, regardless of whether you’ve reached the next billing milestone.

There can therefore be a gap between paying your team to do the work, invoicing the client and eventually receiving the cash. The more work you have going through the business, the more significant that gap can become.

You’ve invoiced the work, but the client hasn’t paid

Raising the invoice still doesn’t mean the cash is in the bank.

Depending on who you work with, it could be another 30, 60 or 90 days before the money reaches you. Larger organisations, in particular, may have set payment cycles that mean you wait longer to receive your cash.

As a business grows, you can have more and more money tied up in debtors. You might have £200,000 sitting in your sales ledger waiting to be collected, but that’s very different from having £200,000 available in your bank account.

It’s why keeping on top of outstanding invoices matters. You want to know how much you're owed, when you realistically expect that money to arrive and whether there are any older invoices that need to be chased.

You’ve recruited ahead of the growth

People are usually one of the biggest costs in a consultancy business, and recruitment is a good example of why growth can put pressure on cash.

You may know you’ve got work coming in and need another engineer, architect or consultant to deliver it. You recruit that person now and start paying their salary from their first month.

They may need some training before they’re fully up to speed. They may not be completely chargeable from day one and, even once they are working on client projects, you still need to do the work, invoice it and wait for the client to pay.

There can be quite a delay between taking on the additional salary cost and seeing the cash coming into the business as a result of that recruitment.

That doesn’t mean recruiting is the wrong decision. It just needs to be considered when you’re looking at whether the business can afford to take somebody on and when the right time might be.

You’re investing in the business

Growing businesses also tend to need investment.

You might move into a larger office, invest in new software or equipment, train the team, update the website or increase your marketing activity.

All of those things may be sensible investments in the future of the business, but they still require cash. In some cases, the money leaves the business well before you see any benefit from what you’ve spent it on.

So, a falling bank balance doesn't always mean the business is performing badly. You may simply be reinvesting some of the money the business has generated.

Don't forget about tax

Tax is another area that can catch business owners out.

There may be corporation tax, VAT, PAYE and NI payments to make at different points during the year, and depending on the timing, some of those can create significant cash outflows.

The problem comes when you look at the bank balance and treat everything in there as available cash. Some of that money may effectively already be set aside for HMRC.

For some businesses, having a separate bank account or pot for tax can be helpful. It gets that money out of the way so you’re not looking at it as cash you have available to spend within the business.

Money has been taken out of the business

There may also be cash leaving the business that doesn't reduce the profit figure in the way you might expect.

Dividends are one example. Director's loan repayments may be another, depending on your circumstances. Loan and finance repayments can also affect cash differently from how the costs appear in your profit and loss account.

A profitable year therefore doesn't automatically mean all of that profit is sitting there waiting to be taken out. The business may need some of it for its day-to-day operations and, particularly in a growing consultancy, to fund further growth.

Growth can actually put more pressure on cash

It sounds slightly counterintuitive, but as a business grows and becomes more profitable, cash doesn't necessarily become easier.

In a consultancy business, you may need to recruit people before you can deliver the additional work. You then pay those people while the work is being carried out. Once you reach the relevant billing point, you invoice the client and then wait for them to pay.

As the business gets bigger, you may have a larger payroll, more work in progress and more outstanding client invoices than you did when the business was smaller. Although revenue and profit are increasing, the amount of cash needed to keep everything moving can increase as well.

A profitable, growing business can therefore experience cash flow issues without necessarily being in financial difficulty.

Why the bank balance doesn't give you the full picture

It can be very tempting to look at the bank account, see a healthy balance and think everything is going well.

The problem is that the bank balance only tells you where you are today. It doesn't tell you what's coming over the next few months.

What will the salary bill look like? When are the VAT and corporation tax payments due? Which invoices are you expecting clients to pay? What work are you expecting to bill? Are you planning to recruit or make a significant investment?

Once you start putting those things together, the picture can look quite different.

That’s why the bank balance on its own isn't enough to tell you whether the business can afford to recruit, invest or take money out.

What better cash visibility looks like

You’re never going to predict your future bank balance exactly. Projects move, clients pay late and plans change.

It’s about having enough information to see what’s likely to happen and spot any potential cash pressure early enough to do something about it.

That means looking at the cash you’ve got today alongside the invoices you’re expecting clients to pay, the work you expect to bill, your normal operating costs, payroll, tax payments and any significant investments or other outgoings you’re planning.

For many businesses, a rolling 13-week cash flow forecast can be a useful way of doing this. It gives you a reasonably detailed view of the short term without trying to predict too far into the future.

But it needs to be kept up to date. If a client tells you their payment is going to be a month late, that needs to be reflected. The same applies if a project start date moves or you decide to recruit earlier than planned.

The forecast isn't there to predict everything perfectly. It's there to help you see what may be coming.

What does that mean when you're making decisions?

Once you have a clearer picture of your cash position, you can start answering some of the questions that come up all the time in a growing consultancy.

Can we afford to recruit another person? Can we take on the bigger office? Can we invest in that new software? Can we afford to pay a dividend? What happens if our largest client pays us a month late? What if that project we expected to start next month is delayed?

There isn't one answer that applies to every business. It depends on your cash position, your pipeline, your costs and what else is happening within the business.

But you can make those decisions knowing what the next few months are likely to look like, rather than relying on what happens to be sitting in the bank today.

So, if your accounts are showing a healthy profit but you keep wondering where all the cash has gone, it doesn't necessarily mean the business isn't performing well.

Some of the cash may be tied up in work you've delivered but haven't billed yet. Some may be sitting with clients who haven't paid you. Some may have gone into recruitment, tax or investment, and some may be needed to fund the next stage of growth.

Once you understand where the cash is going and what’s coming next, you’re in a much better position to plan ahead and make decisions about growth with confidence.