Profitable companies die of cash

The wholesaler's accountant showed them a profit of 140,000 for the year. Eleven weeks later they could not make payroll and the business was sold for the value of its van.

Nothing in the accounts was false. Profit and cash are two different measurements of the same year, and one of them is an opinion.

Three places the two come apart

Timing. You deliver in March and book the revenue in March. The customer pays in June. Your supplier invoiced you in February on thirty-day terms. For four months you have funded the whole transaction, and the accounts show a profitable March.

Growth. Every new order needs stock, staff and materials paid for before the money arrives. A business growing at forty percent a year is buying next year's sales with this year's cash, continuously. The faster it grows the more it needs, which is why growth kills profitable companies and shrinking ones sometimes throw off cash for years.

Things that are bought once and expensed slowly. A machine costing 200,000 leaves the bank in one afternoon and arrives on the profit statement in ten annual slices. The profit line barely notices. The bank balance does.

Predict

A distributor is profitable, growing 40 percent a year, and pays suppliers in 30 days while customers pay in 75. What happens over the next eighteen months if nothing changes?

Choose one answer

Cash builds up steadily, since every month is profitableCash drains faster the better the business doesIt roughly breaks even on cash — the timing difference is a one-offIt depends entirely on the profit margin

Lock in answer

Watch the balance, not the result

The model below runs a business month by month. Revenue is small and growing; costs are large and growing slowly. Every month has a profit or a loss, and the cash balance is the running total underneath it.

At the opening settings the business reaches breakeven — and does not survive long enough to enjoy it.

Runway

≈ Hypothetical model, not a forecast

Months a cash balance survives when revenue and costs each grow at their own rate.

It assumes

• Revenue and costs each compound at their own steady monthly rate.
• Money arrives in the month it is earned, with no collection delay at all.
• No loan, investment or asset sale arrives to rescue the balance.
• Costs cannot be cut in a hurry, which is the point of freezing that control.

It ignores

• Payment terms, so nothing sits in receivables or payables
• Any funding round, loan or asset sale arriving to save the balance
• Seasonality, one-off costs and the cost of cutting costs
• That growth rates this steady have never been observed anywhere

Move revenue growth alone until the business gets through all thirty-six months without the balance ever going below zero. Then find the lowest growth rate that still manages it.

Revenue growth a month6%

Net burn this month

50,000

Complete months of cash

11

Cash runs out inside the horizon

1

Month revenue first covers costs

23

Breakeven happens inside the horizon

1

Cash at the horizon

585,342

Lowest the balance gets

-221,217

• Cash balance
• Revenue
• Costs

◷ Not there yet — keep moving the controls.

The threshold sits somewhere near eight percent a month. Below it the business still reaches breakeven — the revenue line still crosses the cost line — it just does so after the money has gone. Reaching breakeven in month twenty-three is worth nothing if the trough is in month eleven.

Check

Which of these improves cash this quarter without changing profit for the year at all?

Choose one answer

Raising prices by five percentCollecting from customers in 30 days instead of 60Making redundanciesBuying equipment outright rather than leasing it

Check answer

›Why the accounts are not lying to youOptional

It is tempting to conclude that profit is fiction and cash is truth. It is not quite that.

Cash on its own is also misleading: a business can look wonderful in a month where it collected a large old debt and sold a van. Profit exists to answer a question cash cannot — over a period, did this activity create more value than it consumed?

Both are answers to real questions. The mistake is using one where the other was asked. Investors mostly want the first question answered; the person signing the payroll wants the second, and wants it today.

Worth remembering

• Profit is a judgement about a period; cash is a fact about a day, and businesses close from the second.
• Timing, growth and one-off purchases are the three places where profit and cash separate.
• A profitable business that pays suppliers faster than its customers pay it drains cash faster the more it grows.
• Survival is decided by the depth and date of the cash trough, not by the month breakeven arrives.
• Collecting invoices sooner improves cash without changing annual profit at all.