Managing cash flow in a small business is crucial to its success. Cash flow management includes techniques for collecting cash, budgeting to plan for cash needs, utilizing outside sources such as banks or investors to supplement cash needs, and even legally minimizing business tax liabilities. Techniques for dealing with these functions can range from the simple to the complex, depending on the nature of the business. 

However, one of the most basic ideas is to understand the difference between profit and cash flow.

Cash-based Business

A business that sells its goods or services for cash will not have to deal with this issue. Profits are generated when a sale is made and, therefore, are the same as the cash coming in. Examples might be a retail store, restaurant, or service business such as a plumber or accountant. This is known as the cash basis of accounting. 

Most small businesses operate this way and the accounting process and management of cash flow is fairly straightforward. The business owner simply needs to make sure that sales are enough to cover the expenses of running the business and the personal cash needs of the owner(s).

Businesses That Give Their Customers Time to Pay

Some businesses will sell their goods and services but allow their customers to pay them later. In this situation, the customer is given a bill, invoice or statement that will specify how long they have to pay. Repayment terms vary considerably but, in general, thirty days is normal. 

Examples might be an auto parts store that sets up an account for an auto repair shop that makes many purchases over a period of time, or a manufacturer who buys parts or materials from a supplier. This is known as the accrual basis of accounting.  Many larger companies operate this way, although size is not always the determining factor. This involves more complex accounting methods because now, according to accounting and tax rules, there is a difference between profit and cash flow. Just looking at the bank balance is not enough.

Keep in mind that some businesses will combine both types of methods which can add to the complexity.

Cash Basis Versus Accrual Basis

Generally Accepted Accounting Principles (GAAP) and the Internal Revenue Code (IRC) allow for both types of accounting methods. GAAP is concerned with accounting that provides users of a company’s financial information such as investors and banks (external users) and company management (internal users) with a level of standardization in using the information. 

The IRC is concerned solely with raising tax revenue but allows for methods that allow all taxpayers to legally minimize their taxes. GAAP is fairly rigid but, surprisingly, the IRC allows for some interpretation.

Accrual basis accounting is the norm from a GAAP standpoint unless your business is truly a cash-based business. However, the IRC allows both methods and the business taxpayer can pick the treatment that legally minimizes their tax liability. As a result, one may find many businesses that use accrual accounting for their financial affairs but convert the books to cash accounting for tax purposes.

Profit Versus Cash

Under the accrual basis of accounting, there is a difference between profit and cash. This is not the case in the cash basis of accounting. We will focus on the accrual basis.

Under the accrual method, income is recognized when it is earned (not received) and expense is recognized when incurred (not paid). This leads to the concept of receivables and payables.  

In the cash basis of accounting income is recognized when received and expenses are recognized when paid. There are no receivable and payables, just an increase or decrease in the bank account. Profit and cash flow are the same.

When receivables and payables are involved, cash flow issues can become acute if not managed timely and properly. If a business allows customers to take longer to pay than the invoice states, the gap between profit and cash flow widens. If allowed to go too far, the business may not have enough cash to meet its requirements even though it looks profitable. 

On the other hand, if a business pays its bills quicker than their suppliers allow them, they are letting cash go out of the business when it might be used for other needs. Again, the gap between profit and cash flow widens.

Using Aging Reports to Help Manage Cash Flow

As mentioned before, there are several ways to manage cash flow. Focusing on receivables and payables, the use of aging reports can be very helpful.

An accounts receivable aging report is simply a list of customers who owe your business money, how much they owe and how long they have waited to pay. The more time a customer is given to pay from the time an invoice was issued reduces cash flow to the business. Keeping in mind that several invoices issued over different time frames to the same customer may be outstanding, it becomes important to follow up with them if they start to get too far behind.

There are many collection techniques that can be used to do this, but the point is to know how much they owe you and how far you have let them go in comparison to the terms you have extended to them. The longer they are given to pay may also ultimately result in a bad debt, which can be written off, but which also adversely affects cash flow.

An accounts payable aging report is a list of vendors to whom you owe money and how much time they are allowing for payment. The goal here is the opposite of that with receivables. The longer the time period, the better the cash flow. 

However, waiting too long to pay may result in collection efforts against your business and the withdrawal of credit from suppliers who provide crucial goods or services.


When receivables and payables are involved, the concept of discounts received and taken can also affect cash flow. Simply put a discount is offered to promote early payment. This affects the cash flow of both the vendor and the customer. The vendor will offer a discount, such as a 1% discount on the total invoice if the customer will pay within a certain time frame (i.e. 10 days instead of the full payment terms). This will speed up cash flow and decrease the gap between it and profit. 

A customer, likewise, can reduce the amount of cash flowing out of the business by promptly taking all discounts offered by their vendors. Knowing the relationship between profit and cash flow can help business owners determine the benefit of taking or offering these discounts.

Cash Flow Management Conclusion

Cash flow management in a business is crucial and involves numerous techniques. Understanding the relationship between profit and cash flow, particularly in a business that uses the accrual basis of accounting, is one of the more straightforward methods of managing this process.

Many larger companies may employ a Controller and/or a Credit Manager to handle these matters. However, many firms cannot afford to hire a full-time employee for those duties. A small business financial advisor, such as a Certified Public Accountant (CPA), can help those business owners ensure that this information is being recorded, put into an appropriate report format and how that information can be used to manage cash flow issues. 
Get a free consultation with our CPA firm.