A workshop turns over EUR 40,000 a month at a healthy 40% gross margin. The profit and loss shows a solid year. The owner cannot make payroll.
This is not a paradox and it is not rare. It is the single most common way that growing product businesses fail, and the reason is structural: profit and cash measure different things over different timescales, and the gap between them widens exactly when things are going well.
Two different questions
Profit is measured on an accruals basis. Revenue is recognised when you deliver, cost is matched to that revenue, and neither has anything to do with when money actually moves. Cash is the bank balance. It changes when money moves and at no other time.
Consider a single order. A shop orders 200 units at EUR 24 on 60-day terms:
| Event | Day | Effect on profit | Effect on cash |
|---|---|---|---|
| Buy materials | 0 | None — becomes inventory | -EUR 2,880 |
| Pay wages to produce | 5-12 | None — absorbed into inventory | -EUR 1,400 |
| Deliver and invoice | 20 | +EUR 1,920 gross profit | None |
| Customer pays | 80 | None | +EUR 4,800 |
Profit appears on day 20. Cash arrives on day 80. For 60 days the business has funded that order entirely from its own resources, and every additional order overlaps the last one. Take enough of them at once and a genuinely profitable business simply runs out of money.
The cash conversion cycle
The size of that gap has a name and a formula:
Cash conversion cycle = DIO + DSO - DPO
- DIO — days inventory outstanding: average inventory / cost of goods sold x 365
- DSO — days sales outstanding: average receivables / revenue x 365
- DPO — days payables outstanding: average payables / cost of goods sold x 365
Working it through for a business with EUR 480,000 of revenue and EUR 288,000 of cost of goods sold:
| Measure | Average balance | Calculation | Days |
|---|---|---|---|
| DIO | EUR 72,000 | 72,000 / 288,000 x 365 | 91.3 |
| DSO | EUR 59,000 | 59,000 / 480,000 x 365 | 44.9 |
| DPO | EUR 31,500 | 31,500 / 288,000 x 365 | 39.9 |
| Cash conversion cycle | 91.3 + 44.9 - 39.9 | 96.3 |
Ninety-six days. Money leaves for materials roughly three months before the corresponding sale is collected, and the business must be able to fund that gap continuously — not once, but permanently, for as long as it trades at this level.
Why growth makes it worse
Here is the part that catches people. Working capital scales with revenue. Express the requirement per euro of sales:
Working capital intensity = (inventory + receivables - payables) / revenue
For the business above: (72,000 + 59,000 - 31,500) / 480,000 = 0.207. Every euro of annual revenue requires about 21 cents of permanently invested working capital.
Now grow revenue by EUR 200,000 — a 42% increase, unambiguously good news:
| Item | Amount |
|---|---|
| Additional gross profit at 40% | +EUR 80,000 |
| Additional working capital required (200,000 x 0.207) | -EUR 41,400 |
| Additional operating costs to support the growth | -EUR 45,000 |
| Net cash effect in year one | -EUR 6,400 |
Profitable growth, negative cash. The profit is real and it arrives later; the cash requirement is immediate. This is why businesses fail during expansion rather than contraction, and why "sell more" is not a solution to a cash problem — it usually deepens it before it helps.
Before committing to a growth plan, price it. Multiply the planned revenue increase by your working capital intensity. That figure is what the growth costs to fund, and it has to come from retained profit, a facility, or investment. Discovering it afterwards is how good businesses end up taking bad finance.
The three levers
Reduce DIO — inventory days
Usually the largest term and the most controllable. Inventory is cash in a physical form, sitting still. Right-size safety stock with the service level calculation rather than by feel, order more frequently in smaller quantities where the supplier allows it, and be ruthless about slow-moving lines. Stock that has not moved in twelve months is not an asset in any meaningful sense — it is cash you have already spent, and holding it in the hope of recovering full value usually costs more than discounting it now.
Reduce DSO — collection days
Payment terms are a commercial decision that is frequently made by accident:
- Invoice the day you dispatch, not at month end. A week of drift is a week of funding.
- Agree terms in writing before the first order and state them on every invoice.
- Chase before the due date, not after — a short reminder at day 25 on 30-day terms is normal and effective.
- Take deposits on custom or large orders. Fifty percent up front on a made-to-order item removes most of the funding gap.
- Consider early-settlement discounts only when the cash is genuinely worth more than the margin given up.
Extend DPO — supplier days
Negotiate terms rather than take them. A supplier moving you from payment on dispatch to net 30 funds a month of your cycle at no cost. Pay on the due date — not early out of politeness, not late at the expense of the relationship. The one thing not to do is fund yourself by silently stretching suppliers: it works briefly, then it costs you priority, terms, and eventually supply.
The 13-week forecast
Annual budgets are for planning. For cash, the tool is a rolling 13-week forecast, updated weekly, built from actual commitments rather than aspirations.
Each week, one row for money in and money out:
- In: receivables by expected payment date — the date the customer will actually pay, based on their history, not the invoice due date. Plus expected direct sales, using recent averages.
- Out: payroll and related taxes, supplier payments due, rent and utilities, VAT and tax payment dates, loan repayments, and planned purchases.
- Result: closing balance each week, carried forward.
The value is not precision — it is lead time. A forecast showing a shortfall in week nine gives you two months to act, when the available options are ordinary ones: bring an invoice forward, delay a purchase, arrange a facility. The same shortfall discovered in week nine itself leaves only expensive options.
Two practical rules. Include VAT and tax dates explicitly — they are large, lumpy, and the most common cause of an otherwise well-run business being caught short. And track forecast against actual each week; a forecast that is consistently 20% optimistic is still useful once you know it is, and useless if you do not.
Warning signs worth watching for
- Revenue rising while the bank balance falls
- Inventory growing faster than sales
- Receivables growing faster than sales — you are financing customers, not selling to them
- Reaching for supplier credit to cover payroll
- Discounting to accelerate collection rather than to win business
- Not knowing the current bank balance without looking it up
None of these appear on a profit and loss statement, which is the point. Profit tells you whether the business model works — the subject of reading a P&L for a product business. Cash tells you whether the business survives long enough to prove it. You need both, and only one of them will stop you trading tomorrow.