- Profit is the difference between a period’s income and expenses; cash is money in and out of the bank. The gap between them comes from uncollected sales, money tied up in stock, investment and debt repayments.
- Six common sources of the gap: rising receivables, rising inventory, shorter supplier terms, capital expenditure, loan principal repayments and payments to shareholders.
- If a profit-to-cash bridge is prepared every month, the question “we are profitable, so where is the money?” is answered with numbers and the line that needs action becomes visible.
A question business owners may ask is: “The income statement shows a profit, but there is no money in the bank.” This is not an accounting error. The income statement records a sale when it is made and an expense when it is incurred; cash moves when collections and payments happen. Some cash outflows, such as buying a machine or repaying loan principal, never appear as expenses in the income statement at all. This article explains the sources of the gap and how to build a monthly bridge.
Six sources of the gap
| # | Source | Why it affects cash but not profit |
|---|---|---|
| 1 | Higher receivables | The sale is booked as profit, but not yet collected |
| 2 | Higher inventory | Goods bought or made have been paid for but are not expensed until sold |
| 3 | Shorter supplier terms | Payables are paid earlier; the expense is unchanged but the cash outflow comes sooner |
| 4 | Capital expenditure | Buying a machine or building is a cash outflow; it reaches the income statement as depreciation over years |
| 5 | Loan principal repayments | Principal is not an expense; only interest appears in the income statement |
| 6 | Payments to shareholders | Payments such as dividends and loans to shareholders do not reduce profit but do reduce cash |
There are effects in the other direction too: non-cash expenses such as depreciation reduce profit but not cash, and longer supplier terms temporarily increase cash.
Hypothetical example: a profit-to-cash bridge
Hypothetical example — not based on a real company.
| Item (TRY million) | Amount |
|---|---|
| Net profit for the period | 10 |
| + Depreciation (non-cash expense) | 3 |
| − Increase in trade receivables | (6) |
| − Increase in inventory | (4) |
| + Increase in trade payables | 2 |
| − Capital expenditure | (5) |
| − Loan principal repayment | (3) |
| − Payments to shareholders | (1) |
| Change in cash | (4) |
The company made a profit of TRY 10 million, but its cash fell by TRY 4 million over the period (10 + 3 − 6 − 4 + 2 − 5 − 3 − 1 = −4). The bridge shows that cash has largely been tied up in receivables and inventory, and that investment has been funded from operating cash.
How to build the bridge
- Start: Net profit for the period. If you start from EBITDA, do not add back depreciation; deduct interest and tax payments separately.
- Non-cash items: Add back expenses that need no cash movement, such as depreciation and provisions.
- Working capital: Changes in receivables, inventory and trade payables.
- Investment: Purchases and sales of fixed assets.
- Financing: Loan drawdowns and repayments, transactions with shareholders.
- Check: The result must agree with the actual change in bank balances. If it does not, the bridge is not complete until the difference is found.
This structure is a simplified version of the statement of cash flows for management use. The site article What Is Cash Flow From a CFO’s Perspective? explains the conceptual framework; this article focuses on building the bridge.
Where to act
- Receivables: Terms and credit limit policy, collection follow-up. See receivables management.
- Inventory: Analysis of slow-moving and excess stock. See cash trapped in inventory.
- Investment: Plan in advance whether investment will be funded from operating cash or from finance with a suitable maturity.
- Financing: Do not fund long-term investment with short-term credit; include the principal schedule in the cash plan.
- Payments to shareholders: Assess dividends and other payments to shareholders together with the cash plan.
Common mistakes
- Deciding distributions or investment on profit alone: Profit does not mean spendable cash.
- Ignoring the cash needs of growth: As sales grow, receivables and inventory grow; growth can consume cash first.
- Building the bridge only at year-end: The problem is noticed months later.
- Not checking the bridge against the bank balance: A bridge that does not reconcile leads to the wrong conclusion.
What it means for management
“Profitable but short of cash” can be explainable and manageable. A monthly profit-to-cash bridge shows which line the gap comes from and assigns responsibility to the right team: collections to sales and finance, inventory to production and purchasing, investment and distribution decisions to management. For measuring the cash cycle, see the cash conversion cycle.
The figures in the example are hypothetical. Method: This article is professional analysis; it makes no claim that rests on legislation, a provision of a standard or statistics.
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