Cash Is Not the Same as Profit. And You Need Both.

Alright. We’ve already seen how profit is not always the same thing as cash.

So, now let’s look at the opposite type of deviation. Specifically, let’s see how you can have cash in your bank account while still being unprofitable at the same time.

Okay. Let’s say you’re a high-end apparel start-up that sells designer clothing to women. Your sales for the first three months are $60,000, $75,000, and $90,000, which is a healthy, growing trend.

As far as the cost of your goods is concerned, the amount comes out to 70 percent of your revenues. And, since your store is located in the nice part of town, the rent that you pay is pretty high. As such, your total monthly operating expenses are $30,000. And lastly, you start with $5,000 cash in the bank.

With that said, the income statements for your first three months will look like this:

Income Statements

	January	February	March
Revenue	$60,000	$75,000	$90,000
Cost of goods sold	42,000	52,500	63,000
Gross profit	18,000	22,500	27,000
Expenses	30,000	30,000	30,000
Net profit	(12,000)	(7,500)	(3,000)

Now, as you can see, after your third month, you haven’t become profitable yet. However, the amount of money that you’re losing each month is decreasing, which is another good sign.

On the other hand, what does your cash picture look like? Well, as a retailer, you’re fortunate enough to collect money on your sales immediately. Also, let’s say you have an agreement in place with your vendors to pay them for the cost of your goods in 30 days.

Under these circumstances, then, this is how your cash situation changes:

Your Cash Situation by Month

In January, you start with $5,000 in your bank account, and you also add $60,000 in cash sales. On top of this, if you recall, you don’t have to pay for the cost of your goods sold yet.

So, the only cash that you spend is the $30,000, which is used to pay for the monthly operating expenses. And all of this means that the amount of cash you have in the bank at the end of the month is $35,000.

In February, you add another $75,000 in cash sales. But, now you have to pay for the cost of goods sold from January ($42,000). And again, you also have to pay for February’s operating expenses ($30,000).

So, the net amount of cash that you have at the end of the month is $3,000. And when you add this to your cash position at the end of January ($35,000), your bank balance increases to $38,000.

In March, you add an additional $90,000 in cash sales, as well as pay for both the cost of goods sold from February ($52,500) and March’s operating expenses ($30,000).

So, the net amount of cash that you have at the end of the month is $7,500. And once again, when you add this to your cash position at the end of February ($38,000), your bank balance grows to $45,500.

But what’s actually going on here?

Problems and Solutions

Cash-based businesses, including vending machines, laundromats, and restaurants, can get a distorted picture of their actual situation. You see, in your case, the amount of cash in your bank account is climbing every month, even though your company is unprofitable.

That’s okay for a while, as long as you keep your operating expenses from increasing so that you can become profitable.

But, you have to be careful at the same time. You see, if you’re misled into thinking that your business is doing well, and that you can increase your expenses, then you’ll likely stay on the unprofitable path.

And if you fail to achieve profitability and continue operating at a loss, eventually you’ll run out of cash. Then, at that point, you’re in danger of going out of business.

With that said, ultimately, you must be profitable by the standards of the income statement. “Why?” you ask.

Because cash flow in the long run is not a guarantee against unprofitability. And again, in your case, the losses on the books will eventually lead to negative cash flow.

So, if your business has cash in the bank but is unprofitable at the same time, then you need to make improvements in your operations. In other words, you need to bring costs down, or generate more revenue without adding costs.