A business finishes the month with $20,000 in profit and $30,000 less in its bank account. The owner suspects a bookkeeping error. The bookkeeper points to unpaid invoices. Both need a more useful answer: a bridge from the reported profit to the cash that actually moved.
I want that bridge before discussing whether the business can afford another hire, a distribution, or a larger order. A profit figure alone cannot answer those questions.
The distinction is basic, but consequential. An income statement measures performance over a period; a cash flow statement explains cash movements. The SEC’s guide to financial statements (opens in a new tab) explains why those statements need to be read together. The example below applies that distinction to an ordinary operating decision.
Follow one month all the way through
Consider a hypothetical service business using accrual accounting. It starts October with $40,000 in cash. During the month, it earns and invoices $100,000 and incurs $80,000 of expenses. Assume all those expenses are paid in October, there are no noncash expenses, and customers pay only $70,000 of October’s invoices. There are no collections of older invoices.
The business also repays $10,000 of loan principal and distributes $10,000 to its owner. Ignore taxes and all other transactions for this simplified example.
| From profit to the change in cash | Amount |
|---|---|
| Accrual profit: $100,000 revenue less $80,000 expenses | $20,000 |
| Less increase in accounts receivable | −$30,000 |
| Cash used by operations | −$10,000 |
| Loan principal repaid | −$10,000 |
| Owner distribution | −$10,000 |
| Total change in cash | −$30,000 |
| Beginning cash | $40,000 |
| Ending cash | $10,000 |
The same ending balance comes directly from the bank activity: $40,000 plus $70,000 collected, less $80,000 of operating payments, less $20,000 of financing outflows.
Nothing in that calculation requires the profit figure to be wrong. The unpaid $30,000 is still a receivable. Principal repayment reduces a liability. The distribution reduces equity. Those movements affect cash without becoming October operating expenses.
That classification matters. Recording the distribution as an expense would hide the operating result. Ignoring it in a cash forecast would overstate the money available to run the business.
Find out what the receivable balance means
“Cash is tied up in receivables” is a starting point. It does not tell anyone what to do on Monday.
Split the $30,000 into invoices that are within agreed terms, invoices overdue without a dispute, disputed work, and amounts that may not be collectible. Each group needs a different response. A customer with thirty-day terms has not paid late on day ten. An unresolved acceptance dispute will not be fixed by sending the same reminder more often.
There is another distinction worth preserving: work completed but not yet invoiced. It can create a cash delay before the receivables report even shows a problem. A business can improve collections and still wait weeks to issue an invoice.
For each material item, attach an expected collection date and the evidence behind it. “Due October 28 under the contract” and “customer said next week” deserve different confidence levels. A forecast becomes more useful when uncertainty is visible rather than buried in a single optimistic receipts number.
Growth can widen the gap
Suppose the same business adds a large engagement. Staff need to be paid before the first milestone invoice is collected. The engagement may have an attractive margin and still require cash the business does not currently have.
The right question is how much cash is needed between starting the work and getting paid. That leads to specific choices: milestone billing, a different staffing sequence, negotiated supplier terms, financing, or declining work whose payment terms do not fit the business. Which choice is available depends on the contract and the relationships involved.
A margin calculation cannot substitute for that timing analysis. A loan can cover a temporary gap, but borrowed cash also creates repayment obligations. Adding borrowing to a forecast without those future payments makes the improvement look larger than it is.
Give the forecast a decision to support
For a near-term hiring decision, model receipts and payments by week, far enough ahead to cover the next payroll, major supplier commitments, and expected customer collections. The horizon should match the decision; a thirteen-week forecast is one useful format, not a rule that makes every business predictable.
Keep three views distinct: the current bank balance, the expected cash movements, and a delayed-collections case. If the new hire is affordable only when every uncertain receipt arrives on time, that dependency belongs in the decision.
At each review, compare the previous forecast with what happened. Was an invoice late, missing, or disputed? Was a payment omitted? Did someone assume a distribution would stop when it did not? Fix the assumption that failed rather than replacing the forecast with another unexplained number.
The most useful explanation of a cash shortfall names the amount, the timing, and the decision behind it. “We made $20,000” tells part of the story. “We added $30,000 of receivables and paid out $20,000 in principal and distributions” gives the owner something to act on.