Profit and cash are different numbers
Your profit and loss shows income earned and expenses incurred. Your bank balance shows money in and money out. Most of the time they move together. When they do not, the difference is almost always on the balance sheet: something you bought, paid down, took out or are still waiting to collect. That is why a profit and loss on its own cannot explain your cash.
The usual culprits
- Loan principal payments. Only the interest is an expense. The principal reduces the loan, so a $3,000 monthly payment may show as $400 of expense and $2,600 of cash that simply left.
- Owner draws and distributions. Money you take out is equity, not an expense. It reduces cash and leaves profit untouched.
- Equipment and vehicles. On the books they are usually spread over several years as depreciation, while the cash goes out the day you buy them. Federal law now allows 100% bonus depreciation for most equipment acquired after January 19, 2025, which can close the gap on the federal return. New Jersey does not allow bonus depreciation, so the state return still spreads it out.
- Customers who have not paid. An invoice counts as income when you bill it, if you keep your books on the accrual method. The cash comes later, or not at all.
- Inventory. Goods bought but not yet sold are an asset, not an expense. A shelf full of stock is cash you cannot spend.
- Paying down credit cards. The expense was recorded when you charged it. Paying the balance down takes cash without adding any expense.
- Prepaid expenses. A year of insurance paid in advance is mostly next year’s expense, but this year’s cash.
- Sales tax collected. This one works the other way. New Jersey sales tax is 6.625% on most goods, and what you collect sits in your account until the return is due. It makes cash look better than it is, because it belongs to the state.
- Tax payments. Estimated taxes paid from the business account are owner draws for a sole proprietor, Partnership or S Corporation, not business expenses.
A worked example
Isabella runs a flooring supply and installation business as a single-member LLC, reported on Schedule C. Her books and her return both use the accrual method. Her 2026 profit and loss shows $180,000 of profit. Her business checking account started the year at $41,000 and ended it at $25,000. Here is where the money went.
| Profit on the profit and loss | $180,000 |
| Depreciation on the van, not a cash cost | $12,000 |
| Van bought and paid for | ($60,000) |
| Customers owe more than a year ago | ($25,000) |
| More inventory on hand | ($18,000) |
| Insurance paid ahead for next year | ($6,000) |
| Sales tax collected, not yet paid to New Jersey | $4,000 |
| Loan principal payments | ($24,000) |
| Credit card balance paid down | ($9,000) |
| Owner draws | ($40,000) |
| Estimated tax payments from the business account | ($30,000) |
| Change in cash for the year | ($16,000) |
| Profit Isabella is taxed on | $180,000 |
The bank balance fell from $41,000 to $25,000, a $16,000 drop, in a year with $180,000 of profit. Every dollar of the $196,000 difference is on the list. Without the $4,000 of sales tax she is holding for the state, her cash would have fallen $20,000.
The van is the largest item where the tax return can differ from the books. Her books spread the $60,000 over five years, $12,000 a year. If the van qualifies for bonus depreciation and she takes it, her federal profit drops by the other $48,000. Her New Jersey profit does not.
Why it matters for estimated taxes
A sole proprietorship, Partnership or S Corporation generally does not pay federal income tax itself. The profit passes through to the owners’ personal returns, and each owner can owe tax on their share whether or not any of it was distributed. Isabella owes tax on $180,000, not on the $16,000 her bank balance lost.
If you expect to owe $1,000 or more, the IRS expects estimated payments. For 2026 they are due April 15, June 15 and September 15, 2026, and January 15, 2027. Size the payments from the profit and loss, and fund them from a cash plan. A mid-year tax projection shows both numbers side by side.
What to do about it
- Read the balance sheet every month, not just the profit and loss. That is where receivables, inventory, loans and draws show up. See what monthly bookkeeping should include.
- Set aside tax as the money comes in. Move a fixed share of each deposit to a separate account, so the April payment is not a surprise.
- Keep sales tax out of reach. A separate account for collected sales tax keeps it from being spent.
- Match big purchases to cash, not to the deduction. A $60,000 van bought in December saves tax at your rate, not $60,000.
- Collect what you are owed. Receivables that keep growing are profit you are paying tax on before you have the money.
This guide is general information based on the law as of the date above, not advice for your situation. Tax rules change, and the right answer depends on your numbers.