Why a Profitable Company Runs Out of Cash: Working Capital Made Simple

One of the questions we hear most often from managers goes something like this: “The report shows a profit, but there’s no money in the account. Where’s the mistake?”

Usually there isn’t one. Profit and cash are two different things, and a company can be profitable while at the same time having nothing to pay salaries with.

This is one of those questions your accounting software won’t answer, but business analytics answers in seconds, because the answer is pulled together from three different reports at once.

Profit is recorded before the cash arrives

In accounting, revenue is recognised when the invoice is issued, not when the money comes in. Expenses are recognised when the goods or services are received, not when they are paid for.

So a month might look like this:

• you issued invoices worth €100,000: that’s revenue;
• customers will pay in 45 days: the cash isn’t there yet;
• you paid suppliers straight away: the cash has already gone;
• you bought goods for stock: the cash has gone, but it isn’t an expense yet.

The report will show a profit. The bank account will show a deficit. Both figures are correct.

Three places where your money sits

The profit you’ve earned is almost always in one of three places, and none of them shows up in the profit and loss statement:

1. With your customers. Receivables: invoices issued but not yet paid. The longer the payment terms and the later the payments, the more money sits there.
2. In the warehouse. Every item bought and not yet sold is money turned into goods.
3. In investment and loan repayments. Buying equipment or repaying part of a loan reduces cash but barely registers in the profit and loss statement.

In practice, the first two account for nearly every case.

The working capital cycle: one number worth knowing

There’s a simple way to measure the problem: work out how many days it takes for cash to come back into the company:

Cash conversion cycle = inventory days + receivable days − payable days

An example for a trading company:

• goods sit in the warehouse for an average of 60 days;
• customers pay within an average of 45 days;
• you pay suppliers within 30 days.

The cycle: 60 + 45 − 30 = 75 days. That means almost three months pass between spending money on goods and getting it back, and throughout that time the company has to live on something.

This is exactly why a growing company often has less cash than one standing still: every new sale first demands cash and only gives it back 75 days later.

What each part of the cycle tells you

• Inventory days are rising: you’re buying more than you sell, or some goods aren’t moving. The slow-moving stock report shows this.
• Receivable days are rising: customers are paying later and later. Debt analytics gives the breakdown by ageing band, and the late payments report shows the specific invoices.
• Payable days are falling: you’re paying faster than you need to. That means you’re financing your suppliers with your own money.

Each of the three can be shortened separately, and every day you cut is cash back in the account.

How to spot it earlier

The trouble is that the cycle lengthens quietly. No single month looks bad; it’s just that after a quarter there’s somehow less cash.

In practice, it’s enough to track three things every month:

• growth in receivables compared with growth in sales. If sales are up 10% but receivables are up 25%, you’re the one financing the growth;
• growth in inventory compared with cost of sales. Same principle;
• movement of overdue debts between ageing bands: the earliest warning sign of all.

All three are shown by the balance sheet report together with profit analysis: the first shows where the money is, the second whether it’s being earned at all.

That’s too much for day-to-day monitoring. In practice, all these indicators fit on a single screen: the management summary, a report for managers that’s worth starting the week with.

What to do in practice

The fixes aren’t complicated; the hardest part is noticing in time:

• Shorten payment terms for new customers. Changing them for existing customers is hard; for new ones it’s normal.
• Start collections earlier. On day seven, not day sixty. We’ve written separately about why speed matters more than strictness.
• Review your purchasing. The slow-moving stock list is a direct input into your purchasing plan.
• Negotiate supplier terms. This is often the cheapest source of financing.
• Work out your cycle before you grow. If it’s 75 days, doubling turnover will require correspondingly more working capital, and it’s better to know that before rather than after.

Where to start

All three parts of the cycle are calculated from the same accounting data you already have; no new system is needed.

In the ready-built Power BI report packages for Rivilė and Finvalda users, the debt, inventory and balance sheet reports refresh automatically. That’s precisely the difference between automated and manual reports: you see the cycle lengthening in the same month, not after the annual financial statements, when nothing can be changed any more.

Prices start from €59 a month. See the comparison on the pricing page, and you can see what the reports look like in the examples.