Why there is profit in your books but no cash in the bank

1. The conversation we keep having

An owner sits down with his accounts at the end of the year. The profit and loss statement says the business made ₹40 lakh. He is pleased. Then he opens his banking app, and there is less money in the account than there was in April.

He asks the obvious question, usually with some irritation: "So where is it?"

We have had this conversation hundreds of times. It is the single most common thing business owners ask us, and it is almost never a sign that anything has been stolen or that the accountant has made a mistake. Both numbers are usually correct. They are simply measuring two different things.

Once you understand where the difference goes, you stop being surprised by it — and more importantly, you can do something about it.

2. Why the two numbers differ at all

Your books are kept on what accountants call an accrual basis. It is not a trick, and it is required. It means a sale is recorded on the day you raise the invoice, not the day the money reaches you. An expense is recorded when you incur it, not when you pay it.

This is genuinely the better way to measure whether a business is working. If you only counted cash, a month where three customers happened to pay late would look like a disaster, and a month where you delayed paying your suppliers would look brilliant. Neither would be true.

But it has one consequence that catches owners out constantly:

That is not a flaw in your accounts. It just means the profit statement was never designed to answer that question, and you need a second calculation for it.

3. The five places your cash actually goes

Every rupee of the gap between your profit and your bank balance sits in one of these five. There is no sixth.

1. Money your customers owe you

You invoiced ₹1 crore this year. Your books count all of it as revenue. But if ₹22 lakh of it is still unpaid on 31 March, that ₹22 lakh is profit you have earned and money you do not have. In most businesses we look at, this is the largest single item.

2. Money sitting as stock

Stock is bought with cash and sits on your balance sheet as an asset. It does not touch your profit statement until you sell it. So a year where you built up your inventory by ₹14 lakh is a year where ₹14 lakh of cash quietly turned into things on a shelf — and your profit statement said nothing about it.

3. Money you paid suppliers early

Advances to suppliers, security deposits, prepaid expenses, annual subscriptions paid upfront. All cash out, none of it fully in this year's profit statement. Individually small, collectively often significant.

4. Spending that never appears in profit at all

This one surprises people most, so it is worth being explicit. The following take real money out of your bank account and do not reduce your reported profit:

• Loan principal repayments. Only the interest portion is an expense. The principal is not.
• Buying machinery, vehicles or equipment. The cash leaves at once; the profit statement only sees it slowly, as depreciation.
• Money you take out as an owner. Drawings and dividends come out of profit already earned, not out of the profit statement.
• Advance tax and past tax dues, to the extent they differ from the tax provision in your accounts.

An owner who repays a ₹6 lakh loan and buys a ₹10 lakh machine has spent ₹16 lakh that his profit statement will barely acknowledge this year.

5. Depreciation, working the other way

Depreciation is the one item that runs in your favour. It reduces your reported profit but takes no cash out of your account this year — the cash left when you bought the asset. So when working out where your money went, depreciation gets added back.

4. A worked example, start to finish

Here is the calculation for a business that reported ₹40 lakh of profit and ended the year with ₹3 lakh less in the bank than it started with. Every figure below is illustrative, but the arithmetic is exactly what you would do with your own accounts.

Look at what happened here. Nothing went wrong. Nobody was careless. The business grew, which meant customers owed it more and it carried more stock. It invested in a machine, paid down debt, and the owner took a modest amount out. Every one of those is a reasonable decision.

Together, they consumed ₹43 lakh of a ₹40 lakh profit.

5. Do this on your own numbers

You need three things: your profit and loss statement for the period, your balance sheet at the start, and your balance sheet at the end. Then:

1. Write down your reported profit for the period.
2. Add depreciation and amortisation for the period.
3. Subtract the increase in trade receivables between the two balance sheets. If it fell, add it instead.
4. Subtract the increase in inventory. Again, reverse the sign if it fell.
5. Add the increase in trade payables — supplier credit is a source of cash.
6. Subtract any fixed assets bought during the period.
7. Subtract loan principal repaid, owner drawings and dividends.
8. Compare the result to the actual movement in your bank balance.

If the two do not agree, the difference is something you have missed — and that missing item is usually the interesting one. Your accountant can find it in an hour.

Do this once and it is informative. Do it every month and it becomes an early warning system. That is the reason it forms one of the three core reports in the framework we set up with clients, where it is called the Book-to-Bank report.

6. What to actually do about each one

Knowing where the money went is useful. Getting some of it back is better.

• Unpaid customer bills. Age every invoice by customer. You will usually find a small number of customers cause most of the delay, and that nobody has been following up in any organised way. A routine with names and dates attached changes behaviour faster than owners expect.
• Stock. Separate what turns from what does not. The slow half is where your money is, and it rarely improves by waiting another year.
• Supplier advances. Review payment timing. Paying on the due date rather than early is not sharp practice, it is ordinary discipline.
• Capital spending. Nothing wrong with it, but plan the cash for it rather than discovering the effect afterwards.
• Owner drawings. Work out a safe monthly figure using a rule, rather than taking what seems fine and hoping.

If most of your gap is in the first two, that is a working capital problem and it is usually the fastest thing to fix.

7. When this stops being normal and starts being a problem

Some gap between profit and cash is completely normal, especially in a growing business. Growth consumes cash almost by definition, because you buy stock and extend credit before you get paid.

Start paying closer attention when:

• The gap widens for three or more months in a row without an obvious reason such as a large one-off purchase.
• You are profitable but borrowing to pay routine costs like salaries or GST.
• Money owed to you is growing faster than your sales are.
• You cannot say, in rupees, how much of your money is currently in unpaid bills and stock.

That last one is the real test. Not knowing the number is more dangerous than the number being large.

8. Common questions

Can a profitable business actually run out of money?

Yes, and it happens more often than people think. It is one of the most common ways a growing business gets into serious trouble, precisely because the profit statement keeps looking healthy right up until the point payroll is difficult.

Is my accountant doing something wrong?

Almost certainly not. Both numbers can be entirely correct. What is usually missing is the second calculation that connects them, because nobody ever asked for it.

How often should I check this?

Monthly. Checking once a year means finding out about a problem several months after it started, when far fewer options remain.

Does this apply to a service business with no stock?

Yes, minus the stock line. For service businesses, the gap is usually dominated by unpaid customer bills and owner drawings.

Written by

CA Sajal Goyal

Chartered Accountant with over 20 years in finance, taxation and strategy. He has worked with more than 500 Indian businesses across manufacturing, retail, D2C, services and technology, and built the Finance Control Framework. More about Harshil and Sajal →