Plain answer
Profit records income and expenses under accounting rules; cash changes when money is actually received or paid. A profitable company can therefore use up cash when customers owe more, inventory builds, capital expenditure rises or financing repayments exceed new funding.
A small company announces a £150,000 profit. Its cash balance has fallen by £100,000. The two numbers look as if one must be wrong. They can both be right.
Profit records sales and costs under accounting rules; cash records money arriving and leaving. A business can make a sale, count the revenue, and wait weeks to be paid. It can buy stock for future orders, pay for equipment, or repay a loan. None of those movements is captured by reading the profit headline alone. For an investor, the revealing question is not “was it profitable?” but “what happened between that profit and the closing cash?”
A sale is not the same moment as a payment
Imagine a fictional components maker called Northfield Parts. It delivers a large order in March. The customer owes £180,000, payable later. Under the relevant revenue rules, Northfield may recognise the sale when it has satisfied its promise to the customer, even though the bank account has not yet received the cash. The precise accounting depends on the contract; the simple point is that revenue and receipt need not occur on the same day.
The unpaid amount appears in receivables: money customers owe. If those balances grow, reported sales can race ahead of cash collected. That is not automatically fraud or bad business. A growing company may have sold more on normal credit terms. But if receivables repeatedly rise faster than sales, or old debts are hard to collect, the cash gap deserves attention.
Northfield may also buy raw materials before it can sell the finished goods. More inventory can support growth, yet purchasing or producing it ties up cash. On the other side, if Northfield has not yet paid suppliers, payables temporarily hold cash in the business. Delaying suppliers can improve the period-end balance without creating a stronger underlying business.
Follow the £150,000 through to the bank
Here is a complete simplified bridge for Northfield. All figures are fictional and in thousands of pounds. We assume no tax, interest, dividends, foreign-exchange changes or other cash-flow items. Start with the reported profit, then adjust it for non-cash items and movements in money owed, stock and supplier bills.
Picture it: profit and cash move through different lines. On a phone, swipe sideways to read each column.
| Movement | Effect on cash (£000) | Why |
|---|---|---|
| Reported profit | 150 | Accounting starting point, not cash received |
| Add back depreciation | +50 | Expense in profit, but no current-period cash payment |
| Receivables increased | −180 | More sales remain unpaid |
| Inventory increased | −70 | More cash is tied up in stock |
| Payables increased | +30 | Supplier payments have not yet left |
| Operating cash flow | −20 | The day-to-day business consumed cash overall |
| Capital expenditure | −120 | Cash spent on longer-lived equipment |
| New borrowing | +60 | Financing cash brought in |
| Loan principal repaid | −20 | Financing cash paid out |
| Change in cash | −100 | −20 − 120 + 60 − 20 |
| Opening cash | 240 | Cash at the start of the period |
| Closing cash | 140 | £240,000 less the £100,000 fall |
Check the first half of the bridge: £150,000 profit plus £50,000 depreciation, less £180,000 receivables and £70,000 inventory, plus £30,000 payables, equals £20,000 of cash used by operations. Then £120,000 of equipment spending and a net £40,000 of new borrowing take the total change to negative £100,000. £240,000 opening cash becomes £140,000 closing cash.
This is more informative than saying “profit is not cash” and stopping there. It identifies where the cash went. Northfield has not lost £150,000 of profit somewhere. It has £180,000 more owed by customers, £70,000 more tied up in stock, and a new asset it paid for. Its financing covered some, but not all, of those cash needs.
Why add depreciation back and still subtract equipment?
The cash was not paid again when the £50,000 depreciation expense was recorded. That expense represents a portion of the cost of longer-lived assets recognised in this period, so a simplified indirect cash-flow bridge adds the non-cash expense back to profit.
That does not mean equipment is free. Northfield paid £120,000 cash for new equipment during this period. That purchase appears separately as an investing cash outflow, rather than being treated as a £120,000 expense in the current profit figure. The existing equipment’s depreciation and the new equipment’s cash purchase answer different questions. Counting the purchase as a normal current-period operating expense as well would blur them.
The same separation helps with borrowing. The £60,000 loan brings cash in but is not a sale or an operating profit. Paying £20,000 of principal uses cash but is not, by itself, an operating loss. Interest would need its own treatment, but the fictional example explicitly excludes it. Looking only at the closing cash could make Northfield seem healthier than its day-to-day cash generation; looking only at profit could make it seem healthier too.
When is the gap worrying?
A single period of negative operating cash does not prove that a profitable company is failing. Northfield might have built inventory ahead of a known order and expect the customer to pay shortly. Equipment spending might increase future capacity. Growth and seasonality can create a temporary gap. The question is whether the explanation can be tested against the next period’s accounts and the notes.
Repeated gaps deserve more scrutiny. Are customer balances growing faster than revenue? Is stock building without sales? Are payables rising because suppliers are being paid later? Does the company rely on fresh borrowing or share issues to keep normal operations going? Can it meet debt repayments and committed spending before the expected customer cash arrives? Those questions matter especially for a smaller company with limited financing options.
Cash-flow statements can have their own classification judgements and errors, so do not worship one line in them either. Compare the profit statement, balance sheet, cash-flow statement and notes. An RNS headline is a starting signal; the full accounts show how the figures connect. If a company presents an adjusted profit, first find what was adjusted and then reconcile from the statutory figures that correspond to the cash-flow statement.
What to check in a real set of accounts
Northfield is fictional. For an actual small company, start with the latest full filing and compare at least two reporting periods. Find operating cash flow, then inspect the movements in receivables, inventory and payables. Look at capital expenditure in investing cash flows, debt drawn and repaid in financing, and the opening-to-closing cash reconciliation. Read the notes on payment terms, commitments and borrowings, plus any going-concern discussion.
There is no magic ratio that turns one year of accounts into a verdict. What you can do is refuse to let a profit headline answer a cash question. Northfield’s £150,000 profit says it recognised more income than expense in the simplified period. Its £100,000 cash fall says money left faster than it came in. The bridge shows how both statements can be true, and exactly what an investor should investigate next.