You have just looked at your management accounts and they show a healthy profit for the month. Then you check the bank account and there is barely enough to cover payroll. If this sounds familiar, you are not doing anything wrong — you are simply looking at two different pictures of the same business. One is drawn on an accrual basis, the other reflects cash in the bank. Understanding the gap between them is one of the most useful things an SME owner or finance manager can learn, because it stops you panicking over a ‘cash crisis’ that is actually just timing, and stops you celebrating a ‘profit’ that has not yet turned into money you can spend.
Why Profit and Bank Balance Tell Different Stories
Profit is an accounting measure. It tells you whether the value of what you sold during a period was greater than the value of what it cost you to deliver it, regardless of whether the customer has paid you yet or you have paid your suppliers. Your bank balance, on the other hand, only moves when cash physically arrives or leaves. If you invoice a client £12,000 today but they pay in sixty days, your profit and loss account can show that £12,000 as earned this month, while your bank statement shows nothing until the payment lands. Neither figure is wrong — they simply answer different questions. Profit answers ‘was this a good month commercially?’ Cash answers ‘can I pay the wages on Friday?’
Cash Basis vs Accrual Basis: The Core Difference
Cash basis accounting records a transaction only when money changes hands. You raise an invoice, but nothing is recorded until the customer actually pays. You receive a supplier bill, but it does not appear in your figures until you settle it. Accrual basis accounting instead records a transaction when it is earned or incurred, matching income and costs to the period the work relates to, not the period the cash moves. Limited companies in the UK are required to prepare their statutory accounts on an accrual basis under FRS 102 or FRS 105, because it gives a far more accurate picture of how the business is actually performing over time. Cash basis is simpler and is available to unincorporated businesses, such as sole traders and partnerships, for tax purposes — but it can distort your understanding of true profitability if large invoices or bills fall either side of your year end.
Rule of thumb: accrual accounting matches income and costs to when the work was done or the cost was incurred. Cash accounting matches them to when the money actually moves. If your bank balance and your profit figure never match, that is normal — the question is whether you understand why.
Worked Example: A Consulting Invoice and a Supplier Bill
Imagine a small consultancy, Riverside Advisory Ltd, in March. During the month the team completes a £12,000 project for a client and issues the invoice on 28 March, with payment terms of sixty days. In the same month, the business receives £4,500 of specialist materials and subcontractor support needed to deliver the project, but the supplier’s invoice is not due for payment until late April. No cash actually moves in either direction during March — yet under accrual accounting, both the income and the cost belong to March because that is when the work was carried out. Here is how the two bases would report the same month.
| Item | Accrual basis (March) | Cash basis (March) |
|---|---|---|
| Revenue recognised | £12,000 — invoice issued for completed work | £0 — customer has not yet paid |
| Costs recognised | £4,500 — materials and subcontractors used | £0 — supplier invoice not yet paid |
| Profit or loss for March | £7,500 profit | £0 — nothing recorded yet |
| Change in bank balance | £0 — no cash movement | £0 — no cash movement |
On an accrual basis, March looks like a strong £7,500 profit month. On a cash basis, March looks like nothing happened at all. Both statements are technically true — the difference is entirely down to timing. The accounting entries that sit behind the accrual figures look like this.
| Account | Dr | Cr |
|---|---|---|
| Trade debtors | £12,000 | |
| Sales revenue | £12,000 |
Invoice raised for consultancy work completed and delivered in March; cash has not yet been received from the client.
| Account | Dr | Cr |
|---|---|---|
| Materials and subcontractor costs | £4,500 | |
| Trade creditors | £4,500 |
Materials and subcontractor support received and used on the project during March; the supplier invoice is not due for payment until April.
Notice that no cash account appears in either entry. That is the whole point — the accrual entries recognise the economic reality of the work done, while the actual bank movements will follow later, once the client pays in May and the supplier is paid in April. To see how the £7,500 accrual profit reconciles back to the £0 movement in the bank account, it helps to walk through the adjustments directly.
| Net profit for March (accrual basis) | £7,500 |
| Less: increase in trade debtors (invoice not yet paid) | (£12,000) |
| Add: increase in trade creditors (supplier not yet paid) | £4,500 |
| Net cash movement for March | £0 |
This is exactly the logic behind the ‘cash flow from operating activities’ section of a cash flow statement: start with accrual profit, then strip out the effect of timing differences in debtors, creditors and stock, and you arrive back at what actually happened to the bank balance. Once the client pays in May, the £12,000 will finally hit the bank — by which point March’s profit is old news, but the cash is very real.
Do not confuse this with the VAT cash accounting scheme offered by HMRC, which is a separate decision about when you account for VAT on your sales and purchases. You can use accrual accounting for your management and statutory accounts while still using the VAT cash accounting scheme for VAT returns if you are eligible. Also note that limited companies cannot use cash basis accounting for their statutory accounts — HMRC’s income tax cash basis is only available to unincorporated businesses (such as sole traders and partnerships), where it is the default reporting method with no turnover cap.
What This Means for Your Business
For an SME owner, the practical impact is this: a profitable set of monthly accounts does not guarantee you have the cash to cover your outgoings, and a quiet bank account does not necessarily mean the business is struggling. What matters is looking at both together. A business with strong accrual profit but consistently tight cash is usually suffering from slow-paying customers, generous credit terms, or stock building up faster than it sells — none of which show up in the profit figure itself. Equally, a business that looks cash-rich in the short term because it has delayed paying suppliers is simply borrowing time, not creating profit. Reviewing your debtor days, creditor days and stock turnover alongside your profit and loss account gives you the full picture that neither number can provide alone.
Actionable Takeaways
- Always read your profit and loss account together with a cash flow forecast or statement — never rely on one without the other when judging how the business is really doing.
- When your accrual profit looks strong but the bank balance does not follow, check your debtor days first; it usually means customers are taking longer to pay than the credit terms allow.
- Remember that limited companies must prepare statutory accounts on an accrual basis under FRS 102 or FRS 105 — cash basis is only an option for unincorporated businesses such as eligible sole traders and partnerships, and only for tax purposes.
- Build a rolling thirteen-week cash flow forecast alongside your monthly management accounts so that timing differences between profit and cash are visible weeks before they become a problem.
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