5-minute lesson · Fictional example
Can a profitable company run out of cash?
Yes. Profit and cash measure different things, and bills arrive on their own dates. This lesson shows why, using a made-up company.
After this lesson you should be able to explain why profit, cash available and debt-payment timing differ, and name the dated facts you need to check a real company.
Three ideas that are easy to mix up
Profit compares the sales a company earned with its expenses for a period, such as a month or a year. It tells you whether the work paid off on paper.
Cash available is money the company can use right now to pay someone. When a company sends a customer a bill, that bill is called an invoice. An unpaid invoice (recorded as accounts receivable) is a customer's promise to pay later. It counts toward sales, but you cannot spend it yet.
Liquidity means being able to pay bills when they are due. A company can be profitable and still have poor liquidity if its cash comes in after its bills go out.
Loans add one more wrinkle. Paying back the amount borrowed, called the principal, lowers cash and lowers the loan balance by the same amount. It is not an expense, so in this example it does not reduce profit. Interest, the extra charge for borrowing, is a separate cost; we leave it out here to keep things simple.
Money coming in
- Sale madethen
- Invoice issuedthen
- Customer paysthen
- Usable cash
Money going out
- Expenses duethen
- Debt repayment due
The fictional company
- Day 1: starts with $10,000 of usable cash.
- Day 1: delivers work, earns $20,000 in sales and sends one invoice.
- Day 10: pays $8,000 of expenses.
- Day 20: an existing loan principal payment of $15,000 is due.
Nothing else happens: no other money in or out, no new borrowing and no assets sold. Taxes, interest, fees and noncash charges are ignored on purpose.
Reported profit: $12,000 ($20,000 sales minus $8,000 expenses). That number stays the same whatever day the customer pays, and the $15,000 principal is not part of it.
When does the customer pay?
Before you try it, predict: which payment days let the company make its day 20 loan payment from its own cash?
Day 1
Opening usable cash
Usable cash after: $10,000
Day 10
Pay $8,000 expenses
Usable cash after: $2,000
Day 20
$15,000 loan principal due; only $2,000 on hand
Warning: funding needed $13,000. The payment cannot be made from cash without financing.
Day 30
Customer pays $20,000, after the deadline
Cash arrives later. It does not undo a payment already missed on day 20.
Reported profit: $12,000
Cash before debt payment on day 20: $2,000
Funding needed on day 20: $13,000
Day 30 does not cover the debt. The company is $13,000 short on day 20. Payment on day 30 arrives after the deadline.
Illustrative assumption only. Fictional company, no forecast.
Check your understanding
Three questions about the ideas, not the exercise.
Apply it to a real company
Use the company's dated filings and write down the date of every figure.
- Balance sheet cash on a stated date, and any limits on using it.
- Cash-flow statement: where cash actually came from and went.
- Unpaid invoices and how quickly customers usually pay.
- Debt notes: repayment dates, amounts and the conditions on any credit the company can draw.
If a filing does not give a fact, record it as Unknown rather than guessing.
Go deeper: operating cash, financing cash and promised credit
The cash-flow statement splits cash into groups. Operating cash comes from running the business, such as customers paying and staff being paid. Financing cash comes from lenders and owners, such as borrowing, repaying loans or paying dividends. Repaying principal shows up under financing, which is one reason it does not affect profit.
A promise of future credit, such as an agreed loan the company has not drawn yet, is not cash today. It may come with conditions, and a lender may not have to lend if those conditions are not met. Check the terms before counting it.