Profit is not cash: why a profitable company can run out of liquidity

“If we made money this year, where is it?” It is one of the most common questions in a small business, and it has an answer: profit is an accounting figure, and cash is what is in the bank. They rarely match. Understanding why is the difference between growing calmly and growing from one dip to the next.

Profit and cash measure different things

Profit compares what you have invoiced with what it cost you to achieve it, at the moment it is generated. A December sale counts in December even if you collect it in March.

Cash only changes when money comes into or leaves the bank. The December sale contributes nothing until March, but December’s payroll and suppliers are paid in December.

Between one figure and the other, three things slip in above all: what your customers owe you, stock and debt.

1. What your customers owe you

Imagine a company that sells €600,000 a year with a net margin of 8%: it earns €48,000. If this year its customers go from paying in 45 days to paying in 75, the company has to wait 30 more days for every sale:

€600,000 ÷ 365 × 30 days = €49,315 more in customers’ hands

All of the year’s profit, and then some, is now in receivables. The company is profitable and has less money than a year ago. Measuring the average collection period every month is the simplest way to see it in time.

2. Stock

Every euro of inventory is a euro you have already paid your supplier and haven’t yet sold. If you buy more than you sell, profit doesn’t change, but cash falls.

The most dangerous is stock that doesn’t turn over: material that has been in the warehouse for months. It doesn’t just tie up money; it often ends up sold at a discount or thrown away. Look at your inventory days and whether they rise month after month without sales rising.

3. Debt and investments

Loan installments are paid with cash, but in the income statement only the interest appears: the part of the loan you repay is not an expense. With an investment it is the other way round: if you buy a €60,000 machine, you pay for it today, but in the income statement it is spread over several years as depreciation.

That is why a year with many loan installments or a large investment can have good profit and little cash.

Growing also consumes cash

This is the case that surprises most. A company that sells more needs more stock and has more outstanding invoices, and both are paid for before being collected. If your cash cycle is 60 days, every extra euro of sales forces you to advance money for 60 days.

A practical way to see it: if your sales grow by €100,000 a year and your cash cycle is 60 days, you need roughly €100,000 × 60 ÷ 365 = €16,400 more cash to sustain that growth, on top of what you already had.

How to avoid the surprise

• Look at cash every month, not just the result. Compare how much you had at the start of the month and at the end, and why.
• Make a cash flow forecast a few weeks ahead, with your real collections and payments. We explain how in 8-week cash flow forecast.
• Watch three indicators: collection period, inventory days and payment period. If the first two rise or the third falls, cash will notice even if profit doesn’t.
• Plan growth. Before accepting a large order, calculate how much money you will have to advance and for how long.

Frequently asked questions

Can a company with profits go bankrupt?

Yes. A company that cannot pay its debts when they fall due has a problem even if its income statement is positive. That is why cash is monitored separately from profit.

What is working capital?

In a small business, the money you need for the day-to-day running of the business: what your customers owe you plus stock, minus what you owe your suppliers. The more it grows, the more cash it consumes.

Which indicator best shows the difference between profit and cash?

The cash cycle: the days that pass from when you pay your suppliers until you collect from your customers. Those are the days you finance.