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Profitable, and no money in the bank?
It is the most common question an owner asks and one of the least often answered properly. Profit counts a sale when you make it. Cash counts it when you are paid. Everything in between is sitting in stock you have bought and invoices you have issued, and this works out exactly how much.
Working capital
Worked from figures entered by the reader. Indicative only, and not advice of any kind.
A good part of the profit never becomes cash.
Stock and unpaid invoices are absorbing much of what the business earns. That is normal for a business growing quickly, and it is the reason a profitable year can still feel like a hard one.
From profit to what is in the bank
Customers take
43 days
You ask for 30.
Stock sits for
88 days
Before it sells.
Cash cycle
96 days
Money out to money back.
The cheapest money in the business
$67,945
is sitting in customers' bank accounts purely because they pay about 13 days later than your terms ask. Collecting to your own stated terms would release it, and it costs nothing to try.
Where it went
Stock on hand
−$70,000 of cash consumed
$180,000 to $250,000. More stock on the shelf than a year ago. That is cash sitting in a warehouse.
Owed to you
−$80,000 of cash consumed
$140,000 to $220,000. More sitting in customers' accounts than a year ago. You have done the work and banked none of it.
Owed by you
−$30,000 of cash consumed
$130,000 to $100,000. You have paid suppliers down, which cost cash.
- Working capital consumed cash this period, which is what growth normally does. It is only a problem when it consumes more than the business earns, and that is the line worth watching rather than the profit figure.
- Customers are taking about 13 days longer than your stated terms. That is not a pricing problem or a margin problem, it is a collection problem, and it is usually the cheapest money a business can find.
Indicative only, on the figures you entered. It covers trading working capital and not tax, capital spending or loan repayments, all of which also take cash out of the same account.
The one idea
Growth consumes cash before it produces any.
Every extra dollar of sales needs stock bought before it can be sold, and becomes an invoice that sits unpaid for a month or two after it is. So a business growing quickly is always funding the gap between the two, and the faster it grows the bigger the gap gets.
That is not a problem. It is arithmetic, and it is why businesses fail in good years as well as bad ones. The problem is only ever that nobody worked out how large the gap would be until it was already there.
The method
Four steps from the profit line to the bank balance.
| Step | How it is worked out | Why it matters |
|---|---|---|
| Start with operating profit | Profit before interest and tax, straight from the accounts. | It is the number everyone quotes and the number nobody can spend. |
| Add depreciation back | It reduced the profit and no money left the building. | The first and easiest step between profit and cash. |
| Take out what working capital absorbed | The rise in stock, plus the rise in what customers owe you, less the rise in what you owe suppliers. | This is where the money goes. Stock and debtors up consume cash. Creditors up release it, because a supplier waiting to be paid is lending you money. |
| What is left is the cash | Operating profit, plus depreciation, less the working capital movement. | The figure that explains why a profitable year felt hard. |
Start with operating profit
- How it is worked out
- Profit before interest and tax, straight from the accounts.
- Why it matters
- It is the number everyone quotes and the number nobody can spend.
Add depreciation back
- How it is worked out
- It reduced the profit and no money left the building.
- Why it matters
- The first and easiest step between profit and cash.
Take out what working capital absorbed
- How it is worked out
- The rise in stock, plus the rise in what customers owe you, less the rise in what you owe suppliers.
- Why it matters
- This is where the money goes. Stock and debtors up consume cash. Creditors up release it, because a supplier waiting to be paid is lending you money.
What is left is the cash
- How it is worked out
- Operating profit, plus depreciation, less the working capital movement.
- Why it matters
- The figure that explains why a profitable year felt hard.
A worked example
A good year that cost money.
$165,000 of operating profit on $2,400,000 of revenue. By any reading of the profit and loss, a solid year.
The accounts say yes and the bank account says no.
Working capital is taking more than the business earns. Nothing here is necessarily wrong: growth does this. But it has to be funded from somewhere, and knowing that before the bank does is the difference between arranging it and needing it.
From profit to what is in the bank
Customers take
47 days
Terms say 30.
Cash cycle
91 days
Money out to money back.
Where it went
Stock on hand
−$130,000 of cash consumed
$210,000 to $340,000. More stock on the shelf than a year ago. That is cash sitting in a warehouse.
Owed to you
−$115,000 of cash consumed
$195,000 to $310,000. More sitting in customers' accounts than a year ago. You have done the work and banked none of it.
Owed by you
+$25,000 of cash released
$140,000 to $165,000. You owe suppliers more than a year ago. That is cheap funding, up to the point it becomes a problem.
The business earned $165,000 and produced -$23,000 of cash. Nothing went wrong: it grew, and growing meant carrying $220,000 more in stock and unpaid invoices than the year before. An owner reading only the profit line would have no idea, right up until the day the account ran dry.
What this does not cover
- Tax, which falls due on the profit rather than on the cash
- Loan repayments, capital spending and drawings, all of which take cash from the same account
- Seasonality within the year, which can swing the position hard between the two dates
- Any judgement about whether your stock or debtor levels are right for your industry
Need to show someone the forecast?
This explains the year that has gone. A lender, a landlord or an investor wants the one coming. Three-way forecasts and lender-grade plans start at $850.
Want the finance arranged as well?
This site does the analysis and the documents, and does not arrange credit. The broking is done by The Lending Lab, a separate business run by the same person. Send a few details and Nick handles it himself.
Common questions
Because profit and cash measure different things. Profit counts a sale when you make it. Cash counts it when you are paid. In between, the money sits in stock you have bought and not sold, and in invoices you have issued and not collected. A business growing quickly buys more stock and carries more unpaid invoices every month, so it can be profitable on every line and still have less in the bank than it started with. That is not a failure. It is what growth costs, and it has to be funded from somewhere.
No, and reading it that way is the mistake. A business growing 30% a year should be absorbing cash into working capital, because it is carrying more stock and more debtors to support the higher volume. The question is whether it is absorbing more than the business earns, and for how long. That is a funding conversation, not a performance one.
How many days pass between paying for something and being paid for it. Add the days your stock sits before it sells to the days your customers take to pay, then subtract the days you take to pay your own suppliers. The number left over is how long your money is somewhere else, and every day of it has to be funded by you, by a facility, or by your suppliers.
One day of revenue for every day past your terms. On $2 million of revenue that is about $5,500 a day, so customers running fifteen days over terms are holding roughly $82,000 of your money. It is generally the cheapest funding available to a business, because it costs nothing but the phone calls, and it is the first thing worth fixing before borrowing to fill the same gap.
No. This looks backwards at a year that has already happened and explains where the money went. A forecast looks forwards and is what a lender, a landlord or an investor will ask for. The two work together: this tells you the pattern, the forecast projects it.
General information only. Not credit advice, not a credit assessment, not taxation advice, and not an offer of finance. Andorra Advisory Group does not arrange credit and is not a credit representative.