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MarginGraph

Profitable and broke: the gap between your P&L and your bank balance

Your accountant says you made sixty thousand. Your bank balance fell by sixty-seven. Both are correct. Here are the seven bridges between them, and which ones you can move.

11 min readMarginGraph

There is a specific conversation that happens in a lot of small businesses around the time the annual accounts arrive. The accounts show a profit. The owner knows, with certainty, that there is less money in the bank than there was a year ago. Somebody is assumed to be wrong.

Nobody is wrong. Profit and cash are different measurements of different things, and the distance between them is made of a small number of identifiable items. Once you can name them, the conversation stops being confusing and starts being useful, because most of those items are things you control.

The bridge, in full

A small manufacturer. Profit after tax of €60,000. Bank balance down €67,000 over the same year.

€Running total
Profit after tax, per the P&L60,00060,000
Increase in receivables−38,00022,000
Increase in inventory−22,0000
Increase in payables+9,0009,000
Depreciation added back+14,00023,000
Van and machine purchased−31,000−8,000
Loan principal repaid−18,000−26,000
Last year's corporation tax paid−11,000−37,000
Owner drawings−30,000−67,000
Net movement in the bank−67,000

A €127,000 gap between the profit figure and the cash figure, and not one line of it is an error.

The seven bridges, one at a time

1. Revenue recognised before the cash arrives

Under IFRS 15, revenue is recognised when the performance obligation is satisfied, which is when you deliver, not when you are paid. If you have not been paid, the amount sits on the balance sheet as a receivable.

Where it shows up: the P&L in full on the day you invoice. The balance sheet as a receivable. The cash flow statement only as the movement in receivables, which is a deduction from profit under the IAS 7 indirect method.

Here, receivables grew €38,000. That is €38,000 of profit you have earned and not received. If revenue grew, this line grows automatically, which is why a good year can feel worse than a flat one.

2. Inventory

Buying stock is not an expense. It is converting one asset into another. The cost only hits the P&L when the item is sold.

Where it shows up: nowhere in the P&L until sale. Balance sheet as inventory. Cash flow statement as the change in inventories.

€22,000 of cash is now sitting in the warehouse. If you have ever wondered why a well-stocked business feels poor, this is why.

3. Capital expenditure

IAS 7 classifies payments to acquire property, plant and equipment as investing cash flows. They never touch operating cash flow, and they never touch the P&L. Only depreciation touches the P&L, spread across the asset's useful life.

Where it shows up: the full €31,000 as an investing outflow. €14,000 of depreciation as a P&L charge, added back in the cash flow statement because it is not cash.

This is the bridge that surprises people most: you can spend €31,000 on a van and see a few thousand euros of it in your profit figure.

4. Loan principal

IAS 7 classifies "cash repayments of amounts borrowed" as financing cash flows. Interest is an expense in the P&L. Principal is not an expense at all: it reduces a liability.

A €2,000 monthly loan payment of which €250 is interest shows €250 in your P&L and takes €2,000 out of your bank account. Over a year that is €3,000 of cost and €24,000 of cash.

5. VAT

VAT is neither revenue nor expense. It sits on the balance sheet as a payable. Under the EU VAT Directive the tax becomes chargeable when the supply is made, not when the customer pays, so if you invoice on 60-day terms and file quarterly, you can be remitting tax on money you have not received.

Where it shows up: nowhere in the P&L. Balance sheet as a payable. Bank account, sharply, four times a year.

6. Corporation tax timing

Under IAS 12, the current tax charge is recognised as a liability to the extent it is unpaid. The charge and the payment are different events in different periods. In the UK, tax is due nine months and one day after the accounting period end, with quarterly instalments for companies with taxable profits above £1.5 million, and an earlier instalment schedule above £20 million.

The consequence for a growing company: you pay last year's tax bill out of this year's tighter cash, and if you cross the instalment threshold, payments move forward into the accounting period itself.

7. Owner drawings and dividends

Neither is an expense. IAS 7 permits dividends paid to be presented as either an operating or a financing cash flow, at the entity's choice, and financing is the common presentation. Drawings by a sole trader or partner are a reduction of capital.

Either way they reduce your cash and your equity and leave your profit untouched. This is the single most common reason an owner sees a profit that does not exist in the bank, and it is the only line on the list that is entirely within your control this afternoon.

The measurement that ties it together

The cash conversion cycle expresses bridges one to three as a single number of days:

CCC = DSO + DIO − DPO

  • DSO, days sales outstanding: average receivables ÷ (revenue ÷ 365)
  • DIO, days inventory outstanding: average inventory ÷ (cost of goods sold ÷ 365)
  • DPO, days payables outstanding: average payables ÷ (cost of goods sold ÷ 365)

Like burn rate and free cash flow, none of these is defined in any accounting standard. Practitioners differ on average versus closing balances and on 360 versus 365 days, and the two conventions give materially different answers on the same accounts. The SEC's own guidance on non-GAAP measures notes that free cash flow "does not have a uniform definition and its title does not describe how it is calculated." Write down your convention and stick to it, and be careful comparing your number to a published benchmark computed differently.

What the evidence actually says about shortening it

Here the honest answer is more interesting than the popular one.

Deloof (2003), studying 1,009 large Belgian firms across 5,045 firm-year observations, concluded that "managers can increase corporate profitability by reducing the number of days accounts receivable and inventories." His fixed-effects results give significant negative coefficients on receivable days and inventory days, while the coefficient on the cash conversion cycle as a composite is not significant. Check that table yourself before repeating it, because most secondary summaries of this paper assert the opposite. His negative coefficient on days payable is best read as reverse causality, and he says as much: "Less profitable firms wait longer to pay their bills."

Baños-Caballero, García-Teruel and Martínez-Solano (2012), studying Spanish SMEs, found "a non-monotonic (concave) relationship between working capital level and firm profitability, which indicates that SMEs have an optimal working capital level that maximizes their profitability." There is an optimum. Cutting past it destroys profit through stockouts and lost customers.

Chang (2018), using global data, found a negative relationship between CCC and both profitability and firm value, with the benefit diminishing at low levels.

Aktas, Croci and Petmezas (2015), on US firms from 1982 to 2011, found firms moving toward their optimal working capital level performed better, whether that meant increasing or decreasing it.

The consensus is not "shorter is better." It is "there is an optimum, most firms are on the high side of it, and the components matter more than the composite." All of these are correlational panel studies on larger or listed firms, so none of them establishes causation for a business your size.

Growth is a cash consumer

Churchill and Mullins named the constraint in Harvard Business Review in May 2001: the self-financeable growth rate, "the rate at which a company can sustain its growth through the revenues it generates without going hat in hand to financiers."

Their arithmetic runs from the operating cash cycle. In their worked example, 70 days of receivables plus 80 days of inventory give a 150-day operating cycle. Thirty days of supplier credit does not shorten that cycle; it reduces the cash tied up inside it, which comes to 65.5 cents per dollar of sales against a cash profit of 5 cents per dollar. That gives 5 ÷ 65.5 = 7.63% per cycle, and 365 ÷ 150 = 2.433 cycles per year, so 18.58% is the fastest this company can grow on its own money.

Above that rate, growth consumes cash faster than it produces it, and the business needs outside funding regardless of how profitable it is. This is the mechanism behind why a growing business can feel poorer than a flat one. Service businesses achieve higher self-financeable growth rates than manufacturers or distributors, for the obvious reason that they carry less working capital.

How the gap gets funded, and what it costs

In the euro area, 39% of firms reported using financing for inventories and working capital in the first quarter of 2026, from a sample of 10,544 firms of which 92% had fewer than 250 employees. A net 24% of SMEs reported increased bank loan interest rates in the same quarter.

In the UK, the traditional product for exactly this problem has largely disappeared. According to the British Business Bank, overdraft stock outstanding fell to £7.3 billion in December 2025, the lowest value on record, down 54% in nominal terms and 68% in real terms since 2012.

Where owners go instead deserves a warning. In the Federal Reserve Banks' 2026 Report on Employer Firms, drawing on the 2025 Small Business Credit Survey, 60% of firms borrowing from online lenders reported costs higher than expected, against 37% at small banks and 32% at large banks.

The reason is a disclosure problem. A factor rate is not an interest rate. A factor rate of 1.35 means you repay 1.35 times what you received, with no time dimension attached, so the same factor rate repaid over six months and over eighteen months are wildly different costs. A Federal Reserve focus group study found that among participants who had not encountered the term before, "factor rate" was the main source of confusion when reviewing a merchant cash advance offer. California's regulator now requires APR disclosure on sales-based financing, including merchant cash advances, precisely because the conversion does not happen otherwise.

For scale: Opportunity Fund analysed 150 alternative loans and advances held by 104 businesses and calculated an average APR of 93.9%, median 72%, highest 358%. The sample is self-selected toward businesses seeking refinancing, so it skews to the worst deals. It remains a useful reminder to convert every offer to an APR before comparing it to anything.

What to do with this

Run the bridge for your own last twelve months. Start with profit, add back depreciation, then subtract the movement in receivables, inventory and payables, then capex, loan principal, tax paid and drawings. It should land on your actual change in bank balance. If it does not, something is missing and finding it is the whole exercise.

Then read the three largest lines. Those are where your cash went. In the example above they were receivables, drawings and capex, which is a completely different set of actions from the ones you would take if the answer had been inventory and loan repayments.

What this does not tell you

The bridge is backward-looking. It explains where the money went, not where it will go. For that you need a forward cash schedule.

It also does not distinguish between good and bad reasons for cash absorption. €22,000 of extra inventory might be an efficient response to unreliable supply, or it might be dead stock. The bridge cannot tell the difference. It tells you where to look.

Finally, none of the academic evidence above was collected on businesses of the size likely to be reading this. The direction is well established. The magnitudes are not yours.

Working capital changes the price

A buyer normalises working capital before naming a number. The report shows the calculation, the assumption, and where the figure came from in your file.

Business Valuation report — €9

Sources

Frequently asked

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Does working capital affect valuation?

Yes, through the working capital peg — the normal level a buyer expects to come with the business. Anything short is deducted from what you receive.