FROM PRICE TO BUSINESS
Can a profitable company
run short of cash?
Yes. In lesson 3, we explored how expectations move a share price. Now we look inside the business. To judge those expectations, we must understand what the accounts measure — and when customers actually pay.
What was earned from sales?
Revenue is recognised when the relevant goods or services are provided under the applicable accounting rules. Receiving payment can happen before or after that moment.
What remains after expenses?
Net profit deducts recognised expenses, including depreciation, interest and tax. It measures accounting performance over a period, rather than the change in the bank balance.
What cash moved?
Cash flow records receipts and payments. Operating activities, investment and financing are shown separately. A loan can increase cash without generating revenue or profit.
A FICTIONAL WORKSHOP · ONE PERIOD
€100 of sales.
€20 of profit. No operating cash.
Imagine a workshop that delivers €100 of work. Customers pay €70 now and owe €30. Materials and wages cost €60, all paid during the period. Existing equipment contributes a €10 depreciation expense. Tax is €10 and is paid immediately. There is no interest, inventory change or supplier credit.
€100 revenue − €60 costs − €10 depreciation − €10 tax
€20€70 collected − €60 paid costs − €10 paid tax
€0€20 profit + €10 depreciation − €30 increase in receivables
€0The €30 customer debt is a receivable: a claim to future payment, not cash already received. Depreciation allocates the cost of equipment over its useful life; adding it back in the cash-flow reconciliation does not create money.
If the workshop also pays €20 for new equipment, our simple free-cash-flow measure is €0 − €20 = −€20. It needs opening cash or funding to bridge the gap. That is a financing question, not proof that the €20 profit was invented.
TRY IT · COLLECTIONS AND REINVESTMENT
Same profit.
Different cash outcome.
Move the controls. Revenue stays €100 and net profit stays €20. How quickly customers pay and how much the business invests determine the cash remaining.
Profitable, but cash is leaving the business. Existing cash or external funding must cover the gap.
LOOK BEHIND THE HEADLINE
Growth can absorb cash.
Picture a distributor expanding into a new region. It stocks its shelves before making sales, and customers pay two months after delivery. Even if each sale earns a profit, faster expansion can require more cash in inventory and unpaid invoices. Supplier credit can partly offset that need.
The reverse also happens. An annual subscription paid upfront brings in cash before all the associated revenue is earned. That cash comes with an obligation to provide the service. Strong collections are useful, but they do not make every euro immediately available to shareholders.
Free cash flow needs a definition.
Here we use operating cash flow minus capital expenditure. Company definitions can differ: check the reconciliation, especially for leases, acquisitions and adjustments. Cash left after capital expenditure is not automatically a dividend; debt repayment and other commitments may still take priority.
Equity compensation is another useful test. It may be added back as a non-cash expense, yet it can dilute shareholders. Buying back enough shares to offset that dilution costs cash. Examine cash generation per share as well as the total.
AN OWNER'S CHECKLIST
Read the three measures together.
- Start with sales. What drove growth: more customers, higher prices, acquisitions or currency?
- Follow the margin. Is profit improving because operations are stronger, or because of a one-off gain?
- Reconcile profit with operating cash. Look for changes in receivables, inventory and supplier payments.
- Deduct the investment needs. Ask what must be spent to maintain the business and what is intended to expand it.
- Compare several years. A weak quarter can reflect timing. Repeated shortfalls deserve investigation.
Negative free cash flow can finance worthwhile growth or reveal an unsustainable business. Positive cash flow can reflect durable economics or temporary actions such as selling inventory and delaying bills. The explanation matters as much as the sign.
CHECK YOUR UNDERSTANDING
The workshop collects the missing €30 next period. Does that create another €30 of revenue?
No. The sale was already recognised. Collection increases cash and reduces receivables; it does not record the same sale twice.
A company borrows €50. Has it generated €50 of free cash flow?
No. The borrowing is a financing cash inflow accompanied by a debt obligation. It is outside the operating-cash-flow-minus-capex measure used here.
THE MITUXA RULE
Trace the journey from sales to cash.
How much cash can this business generate after the investment it needs — and what claims remain on it?
FURTHER READING
Accounting background: SEC · Beginners’ Guide to Financial Statements and SEC · The Statement of Cash Flows. The workshop and interactive model are original simplified teaching examples, not company forecasts.