There is no accounting rule that stops a business from reporting a healthy profit in the same month its bank account goes into overdraft. The two figures answer different questions. Profit measures how much the business earned over a period under accrual accounting. Cash measures what actually reached the bank account. Over the life of a business the two numbers converge, and inside any single quarter they can move in opposite directions.

The failure is rarely sudden and rarely obvious. A business wins work, hires to deliver it, buys stock ahead of a stronger quarter, and watches revenue land in the ledger while the invoices sit unpaid for weeks. Each decision holds up on its own. Together they drain the account, and the profit and loss statement keeps reporting a good month.

This article works through the reasons profit and cash separate, then builds a monthly bridge in Excel that reconciles the income statement to the movement in the bank. The example uses one Australian trading business with round numbers, and every line in it ties.

Why a Profitable Business Can Run Short of Cash

Take a wholesale business in the middle of a growth year. This is one month of its income statement, prepared on an accrual basis and stated excluding GST.

The business reports a profit before tax of 18,000 for the month. In the same four weeks its bank account falls by 24,700 and finishes at 5,300. Nothing in the accounts has been misstated and no transaction is missing. The money went into stock, into a new asset, into the loan book and into liabilities that had not been paid yet.

Accrual Timing and the Gap Between Invoice and Bank

Accrual accounting records revenue when the goods are delivered or the work is completed, whatever the payment terms say. It records expenses when the cost is incurred, whatever the payment date. Almost every difference between profit and cash starts with that timing.

Work through a trading month. Revenue appears in the income statement on the day the customer is invoiced. The customer pays later, so the invoice sits in trade debtors while the business waits. A business with rising revenue carries a rising debtor balance at all times, and it pays tax on profit that is still sitting in someone else's bank account.

Expenses move the other way sometimes. A prepaid insurance premium, an annual software licence or a quarterly rent payment leaves the bank weeks before the expense is recognised in the income statement. Where the income statement shows a smooth monthly charge, the movement in the bank shows a single lump.

Stock shows the same pattern with a longer lag. A purchase of inventory is cash out on delivery, and the goods sit on the balance sheet as an asset until a customer buys them. Cost of goods sold appears in the income statement in a later month, alongside the revenue it belongs to. The cash went out first and the expense arrived second.

None of this is an error in the accounting. It is the reason a profit forecast cannot stand in for a cash forecast.

The Working Capital Drag of Growth

A growing business has to fund growth before it collects the profit from it. Trade debtors and inventory both rise, and each increase is cash that has already left the account.

In the example month, invoiced sales were 120,000 and cash collected from customers was 95,000. Debtors rose by 25,000, and the movement ties to the opening balance.

55,000 opening debtors + 120,000 invoiced - 95,000 collected = 80,000 closing debtors

Inventory rose by 8,000 over the same month. The business spent 80,000 on stock to record a cost of goods sold of 72,000, and the extra 8,000 is sitting on the balance sheet. Trade creditors rose by 6,000, which is the one working capital line that helps. The business received goods during the month and had not paid for all of them by month end.

Add the three movements and working capital absorbed 27,000 of cash in a month when the business recorded a profit before tax of 18,000. Growth is the cause. A business with flat revenue can run on the same debtor and stock balances indefinitely. A business growing at 20% a year has to fund a debtor balance that grows at roughly the same rate, and the funding comes out of cash or out of a facility.

Three ratios turn this into a number a finance manager can track, and they belong in the model next to the bridge.

Debtor days            = AVERAGE(opening debtors, closing debtors) / revenue * days in period
Inventory days         = AVERAGE(opening inventory, closing inventory) / cost of goods sold * days in period
Creditor days          = AVERAGE(opening creditors, closing creditors) / purchases * days in period
Cash conversion cycle  = debtor days + inventory days - creditor days

On these numbers, average debtors were 67,500 against 120,000 of revenue in a 30 day month, which comes to 17 days. Opening debtors represented 14 days of sales and closing debtors represented 20, so the collection cycle stretched inside a single month. That stretch is a cash event, and it appears in the bridge as the 25,000 debtor movement. A monthly review of the pattern catches it while it is still small.

Capital Spending, Loan Principal and Owner Drawings

Three outflows use cash without reducing profit, and a forecast built from the income statement alone will miss all three.

Capital expenditure is the first. This business paid 10,000 for equipment during the month, and the payment left the bank account on the delivery date. The 3,000 depreciation charge in the income statement is an allocation of the cost of earlier asset purchases across the years that benefit from them. The payment and the charge describe different assets and different periods, and only the payment moved cash.

Loan repayments are the second, because the repayment splits into two parts. Interest is an expense and reduces profit. Principal reduces the loan balance on the balance sheet and leaves profit untouched. In the example month, 5,000 of principal left the business. A cash forecast that includes only interest understates the requirement by the principal amount, and in the early years of a loan the principal is often the larger part of the repayment.

Drawings and dividends are the third. A company pays dividends out of after-tax profit, and a sole trader or trust pays drawings to the owner. Neither is an expense, so neither reduces profit, and both take cash out of the account. The example includes 5,000 of drawings in the month. The same treatment applies to a dividend, with the timing set by the company's distribution policy.

GST Collected Is Money the Business Owes

GST is the most common way an Australian business spends cash it never owned. The business collects 10% on its sales, claims credits on its purchases, and holds the net amount until the next activity statement is lodged and paid.

The example month makes the size of it clear. Sales of 120,000 carried 12,000 of GST. Purchases of 80,000 and operating expenses of 27,000 carried 10,700 of credits between them, made up of 8,000 on the stock purchases and 2,700 on the expenses. The difference of 1,300 stayed in the bank as a liability owed to the ATO.

Nothing separates that cash from the rest of the account unless someone separates it. Payroll, stock and a new vehicle are all paid from the same balance, and the obligation does not shrink because the money was spent. A business that lodges quarterly faces the same issue on a larger scale, because three months of collected GST accumulates before the payment falls due. Lodgement frequency depends on the registration and turnover of the business, and the ATO sets the cycle.

The practical fix costs one transfer. Move the GST portion of each customer receipt into a separate account as it arrives, and pay the activity statement from that account. The business then runs its working capital on its own money, and a refund month does not turn into a spending surprise.

Tax and Super Paid on Profit Already Reported

Income tax and superannuation both leave the bank after the expense has been recognised, which means profit is reported in one period and the cash goes out in another.

A company pays income tax at 30%, or at 25% if it is a base rate entity, and it pays through pay as you go instalments during the year. Those instalments are based on earlier income, adjusted as the year progresses, and they fall due quarterly. On an annualised profit before tax of 216,000, a base rate entity accrues tax at roughly 4,500 a month and pays about 13,500 in one quarter. The liability sits on the balance sheet between the accrual and the payment, and the quarterly payment is the month the bank account feels it.

Superannuation follows the same shape. The guarantee sits at 12% of ordinary time earnings, the wage cost is expensed when the wages are earned, and the payment is made on the quarterly due dates. A quarterly wage bill of 60,000 carries 7,200 of super that leaves the account in a single payment after the quarter closes.

The bridge in this example covers a month with no instalment due, so it runs from profit before tax. In a quarter-payment month, the instalment and the super payment appear as two more lines in the same bridge, and the closing cash line moves accordingly. That is the month a profitable business most often discovers it has a cash problem.

A Monthly Cash Bridge in Excel

The bridge is a small table, one column per month, and it is built from the balance sheet rather than from the cash book. That choice makes it self-checking.

The sign convention is the part that catches people. An increase in an asset uses cash, so debtors and inventory enter the bridge as negatives. An increase in a liability provides cash, so creditors and the GST liability enter as positives. Depreciation is added back because it reduced profit without moving cash.

Here is the example month as a bridge.

Every line ties back to a balance sheet movement, and the only inputs from the income statement are profit before tax and depreciation. Set it up with one row per line and the balance sheet movements calculated in place against the prior month.

' One column per month, rows 4 to 18 hold the bridge
Profit before tax         ='P&L'!C18              row 4
Add back depreciation     ='P&L'!C27              row 5
Trading cash before WC    =SUM(C4:C5)             row 6
Trade debtors movement    =-(BS!C12-BS!B12)       row 7
Inventory movement        =-(BS!C14-BS!B14)       row 8
Trade creditors movement  =  BS!C20-BS!B20        row 9
GST liability movement    =  BS!C22-BS!B22        row 10
Cash from operations      =SUM(C6:C10)            row 11
Capital expenditure       =-(BS!C30-BS!B30)       row 12
Loan principal repaid     =-(BS!C40-BS!B40)       row 13
Owner drawings            =-(EQ!C9-EQ!B9)         row 14
Net movement in cash      =SUM(C11:C14)           row 15
Opening cash              =BS!B6                  row 16
Closing cash              =C15+C16                row 17
Tie check                 =C17-BS!C6              row 18, zero means it reconciles

Reading the Cash Flow Statement with the Balance Sheet

A cash flow statement splits movement into operating, investing and financing activities. The bridge above is the operating section and part of the financing section, arranged for monthly review rather than for an annual report.

The balance sheet cash line anchors all of it. Cash at the start of the period plus the net movement equals cash at the end, and the same closing number has to appear on the balance sheet at the same date. When the bridge does not tie, the difference is almost always a balance sheet account that has been left out, such as accrued expenses, prepayments, a provision or an income tax payable.

Read the two statements together and the story is short. Operating cash flow below profit means working capital is absorbing cash, and the bridge names the account doing it. Operating cash flow above profit means the reverse. Investing lines show how much capital spending left the business. Financing lines show how much of the business is funded by debt and how much cash is going back out to lenders and owners.

Two checks belong in the monthly routine once the bridge exists. Confirm the tie check returns zero every month, which proves the bridge and the balance sheet agree. Compare operating cash flow with profit before tax across a rolling twelve months, because a business that reports profit without converting it into cash over a year is funding something, and the balance sheet shows what.

One more point belongs in the model. A foreign operation translated under AASB 121 produces an exchange difference that goes to a translation reserve in equity, and movement in that reserve never touches cash, so it stays out of the bridge.

The monthly bridge is the cheapest control a growing business can have. It reconciles the two statements that matter and it puts the reason for a cash movement in the same line as the cause. From there the routine is short. Keep the GST component of customer receipts in a separate account. Forecast cash weekly for the next thirteen weeks while revenue is rising, because a BAS payment, a super payment and a large supplier run can land in the same week. And watch debtor days every month, since a collection cycle that stretches by three days costs real money before it shows up in profit.

Related reading

• Three-Way Financial Models for Business Decision-Making
• Cash Flow Forecasting for Growing SMEs: An Excel Framework
• EBITDA vs Free Cash Flow for Business Valuation