“Profit does not pay the bills” is one of those phrases that can sound like an accounting cliché, right up until you find yourself running a profitable business that cannot meet its payroll.

I have seen businesses with growing sales, a healthy order book and apparently respectable profits still struggle to pay suppliers, settle their VAT or take money out of the business. On paper, they appear successful. In the bank account, the situation looks very different.

This happens because profit and cash are not the same thing.

A business can record revenue when it raises an invoice, but it may not receive the money for another 30, 60 or even 90 days. In the meantime, it may already have paid the wages, subcontractors, materials and overheads needed to deliver the work.

Consider a simple example.

A business completes a £100,000 contract and earns a £20,000 profit. That sounds like a good result. But before receiving anything from the customer, it has to pay £55,000 for labour and materials and another £25,000 towards its overheads.

If the customer does not pay for 60 days, the business must find £80,000 to finance the work during that period. The contract may be profitable, but the profit does nothing to pay this month’s wages because the cash has not yet arrived.

That gap between making money and receiving money is where many otherwise good businesses get into difficulty.

The problem is that most businesses look at their financial position through only one lens.

• Some concentrate on profit. If the management accounts show a profit, they assume the business is financially healthy.
• Others focus on the bank balance. If there is money in the account, they assume the business can afford to spend it.
• Others prepare a cash flow forecast and believe that, because they can see when the money may run out, they understand their cash position.

Each view tells us something useful. None tells us everything. To manage cash properly, I believe we need to look at the business from three connected but distinct financial perspectives.

Profitability

Profitability tells us whether the business is creating financial value. Is it selling its products or services for more than they cost to provide? Are its gross margins strong enough? Can those margins support its overheads? Is the business making a sustainable operating profit?

These are fundamental questions. A business that cannot make a profit will eventually run out of cash unless its owners or lenders continue putting more money into it.

But profitability does not tell us when the money will be received or paid.

A sale can be profitable and still create immediate cash pressure. A growing order book can increase reported profit while simultaneously draining the bank account. Profitability tells us whether the commercial model works. It does not tell us whether the business can meet next Friday’s payroll.

Operational Cash Flow

Operational cash flow helps us understand whether the normal activities of the business are generating or consuming cash.

It looks beyond the reported profit and considers the way money moves through the operating cycle. How long do customers take to pay? How quickly must suppliers be paid? How much cash is tied up in stock or work in progress? Are margins creating enough cash to support the overhead structure?

This is important because money can enter a bank account from several sources.

A business might receive a new loan, an injection from its owners or the proceeds from selling an asset. These transactions increase the bank balance, but they do not mean the underlying business has become better at generating cash.

A company could have £100,000 in the bank after taking out a loan and still be losing £20,000 every month through its normal operations. The bank balance may look reassuring, but it is providing a false sense of security. Unless the operational weakness is corrected, that £100,000 will gradually disappear, and the loan will still need to be repaid.

Operational cash flow helps strip away that distortion. It asks a more revealing question:

“If we remove new borrowing, owner investment and exceptional cash movements, is the underlying business producing enough cash to support itself?”

That makes operational cash flow more than an accounting number. It becomes a measure of the strength of the business’s financial engine.

Cash Flow Forecasting

A cash flow forecast looks forward.

It estimates when money will enter and leave the bank account and shows the effect on the future cash balance. A useful forecast should include expected customer receipts, wages, supplier payments, tax liabilities, loan repayments, capital expenditure and other significant commitments.

Its purpose is to provide advance warning.

If the forecast shows that the bank balance will fall below a safe level in eight weeks, management has time to act. The business might accelerate customer collections, delay non-essential expenditure, negotiate different payment terms or arrange funding before the situation becomes urgent.

Without that visibility, the first warning may be a failed payment or a call from the bank.

However, a forecast has an important limitation.

It can show us when cash may run out without necessarily explaining why.

For example, a forecast might identify a £75,000 cash shortage in three months. That shortage could be caused by a major customer paying later than expected. It could result from rapid growth requiring additional working capital. It could be caused by an underpriced contract, falling margins or overheads that have become too high.

Those are very different problems, and they require very different solutions.

A temporary timing gap might justify an overdraft or working-capital facility. A permanent operating loss requires changes to pricing, costs or the underlying business model. Borrowing may disguise that problem temporarily, but it cannot solve it.

This is why I believe profitability, operational cash flow and cash flow forecasting must be used together.

• Profitability tells us whether the business is creating value.
• Operational cash flow tells us whether its everyday trading activity is converting that value into cash.
• Cash flow forecasting tells us whether the timing of future receipts and payments will leave the business with enough money to meet its commitments.

Put simply:

“A cash flow forecast tells you when cash may run out. Operational cash flow helps explain why.”

That distinction becomes particularly important when a business is considering funding.

The natural response to a forecast cash shortage is often to ask how much the business can borrow. But that is rarely the best starting point. Before arranging funding, I want to understand what has created the requirement.

Is the business funding a profitable contract before the customer pays? Is growth temporarily absorbing working capital? Is cash trapped in overdue invoices? Or is the business borrowing because its prices, margins or cost structure no longer work?

Funding can be an effective way to bridge a temporary and clearly understood cash flow gap. It can help a business take advantage of growth, invest in productive assets or deliver work that will generate future cash.

But funding also creates future commitments. Interest must be paid. Capital must be repaid. Security or personal guarantees may be required. If the underlying business is already consuming cash, borrowing can make the eventual problem larger rather than solve it.

Throughout this guide, I am going to examine how businesses can understand cash more clearly, build more useful forecasts and make better funding decisions.

The aim is not merely to predict when the bank balance will become uncomfortable. It is to understand the story behind that balance, where the cash is being generated, where it is becoming trapped and whether external funding is supporting a genuine opportunity or concealing a deeper problem.

1. What Is Cash Flow, and Why Is It Different From Profit?

Cash flow is the movement of money into and out of a business. When customers pay, cash flows in. When the business pays wages, suppliers, tax, loan instalments or other expenses, cash flows out.

Profit is calculated differently. It measures the financial result produced by the business over a particular period by matching income with the costs incurred to generate it.

That distinction matters because the date on which income or expenditure appears in the accounts is not necessarily the date on which the money moves through the bank. I find it helpful to think of profit as a measure of performance and cash flow as a measure of movement.

Profit answers: Did the business generate more income than it incurred in costs?

Cash flow answers: What money did the business actually receive and pay during the period?

The two are connected, but they rarely move in perfect alignment.

Unpaid Sales Invoices Can Create Profit Without Cash

Suppose I complete £30,000 of work in March and raise an invoice on 31 March. The customer has agreed to pay within 60 days.

Provided the work has been completed and the income has been earned, the £30,000 sale will normally appear in the March accounts. It will contribute to March’s profit.

However, no cash has been received.

Instead, the £30,000 appears as a debtor, money owed to the business by its customer. The accounts show that the business has earned the income, but the bank account remains unchanged.

If the customer pays at the end of May, the cash arrives two months after the profit was reported.

This delay can be manageable when the business has adequate cash reserves. It becomes more dangerous when several large customers pay late or when the business has committed most of its available cash to delivering the work.

The business may therefore report a strong month while becoming less able to meet its immediate commitments.

An invoice is not cash. It is a claim for cash.

Until the customer pays, the business is effectively financing the customer.

Supplier Payments Can Reduce Cash Before They Reduce Profit

The timing difference can also work in the opposite direction.

Suppose I pay a supplier £24,000 in advance for materials that will be used across several contracts over the next six months.

The full £24,000 leaves the bank immediately. From a cash flow perspective, the effect is instant.

But the entire amount may not reduce profit in the month it is paid. If only £4,000 of those materials are used during the first month, only that portion may be charged against the income for that period. The remaining materials continue to be held by the business for future work.

This means the business could experience a £24,000 cash outflow while recognising only £4,000 as a cost in that month’s profit calculation.

The profit and loss account may therefore look reasonably healthy while the bank balance has fallen significantly.

This is one reason I am cautious when someone tells me that a business is performing well based solely on its reported profit. I also want to know how much cash has been committed to suppliers and how quickly that investment will be converted into customer receipts.

Stock Ties Up Cash Until It Is Sold

Stock provides another clear example of the difference between profit and cash.

Imagine a retailer buys £50,000 of stock in preparation for a busy season. The supplier requires immediate payment, so £50,000 leaves the bank.

The purchase does not necessarily create an immediate £50,000 loss.

The unsold goods are recorded as stock because the business still owns something of value. The cost generally becomes part of the profit calculation when the stock is sold.

If the business sells half of the stock during the season, only the cost relating to those sales is charged against the revenue. The other half remains on the balance sheet as stock.

From an accounting perspective, that is logical. The remaining stock may generate income in the future.

From a cash perspective, however, the money has already gone.

If the stock sells slowly, becomes obsolete or has to be discounted, the business can have a large amount of cash trapped on shelves. The accounts may show a valuable stock asset, but that asset cannot normally be used to pay this week’s wages without first being sold and converted back into money.

The practical question is not simply how much stock the business owns. It is how quickly and profitably that stock can be turned into cash.

Work in Progress Can Create the Same Problem

The same principle applies to service, construction and project-based businesses through work in progress.

Suppose a company begins a four-month project. During the first two months, it spends £70,000 on labour, subcontractors and materials but cannot invoice the customer until a contractual milestone is reached in month three.

The company is creating something of value. Depending on the accounting treatment, some of the expenditure may be held as work in progress rather than reducing profit immediately.

But the employees, subcontractors and suppliers still need to be paid.

The project may ultimately generate a good margin, but the business must finance the work until it reaches the invoicing milestone—and then potentially finance the customer’s payment terms after the invoice is raised.

A project that looks profitable in the estimate can therefore produce severe cash pressure during delivery.

This is why I consider payment structure to be part of pricing and project management, not simply an administrative detail. Deposits, stage payments and carefully chosen billing milestones can materially reduce the amount of cash the business must risk.

Tax Creates Cash Outflows at Different Times From the Profit

Tax is another area where profit and cash frequently become confused.

VAT is the clearest example.

Suppose a business invoices a customer £12,000, consisting of £10,000 plus £2,000 VAT. When the customer pays, £12,000 enters the bank.

However, the business has not earned all £12,000. Subject to any allowable input VAT, the £2,000 VAT belongs to HMRC.

If the business treats the full receipt as available cash and spends it, it may struggle when the VAT return becomes payable.

The bank balance was correct, but the interpretation was wrong. Some of the visible cash was already committed.

Corporation tax creates a different timing issue. A company may make a profit throughout the year, but the associated corporation tax is generally paid later. Unless the business regularly reserves for that liability, the eventual payment can produce a significant fall in cash.

PAYE and National Insurance create similar pressures. The cost of employing someone may already be reflected in the profit calculation, but the deductions and employer liabilities must still be paid to HMRC according to the relevant payment timetable.

Tax should never be treated as a surprise. But without proper forecasting and cash separation, predictable tax liabilities frequently become cash flow emergencies.

Loan Repayments Reduce Cash but Do Not Reduce Profit in the Same Way

Loan repayments are often misunderstood because each payment can contain two separate elements:

• Interest.
• Repayment of the amount originally borrowed.

The interest is normally a cost to the business and reduces profit.

The capital repayment does not normally reduce profit because it is paying back a liability rather than purchasing a new good or service. Nevertheless, the entire payment leaves the bank account.

Suppose a business makes a monthly loan payment of £5,000, of which £1,000 is interest and £4,000 is capital repayment.

The profit and loss account may show a finance cost of £1,000. The cash flow shows an outflow of £5,000.

Across a year, that difference amounts to £48,000.

A business could therefore report an annual profit of £60,000 but use £48,000 of cash to repay loan capital. Before considering tax, dividends, investment or changes in working capital, only £12,000 of that apparent profit would remain as cash.

This is why I do not assess borrowing affordability using profit alone. I want to know whether the business will generate sufficient cash, at the right times, to meet both the interest and the capital repayments.

Capital Expenditure Uses Cash Before It Reduces Profit

Capital expenditure includes money spent on assets expected to benefit the business for more than one accounting period. This could include:

• Machinery.
• Vehicles.
• Computer equipment.
• Office improvements.
• Production equipment.
• A new business system.

Suppose a company purchases a machine for £60,000 and pays for it immediately.

The bank balance falls by £60,000.

However, the business would not normally recognise the entire £60,000 as an expense in that month’s profit and loss account. Instead, the machine is recorded as an asset and its cost is spread over its expected useful life through depreciation.

If the machine is depreciated over five years, the annual depreciation charge might be £12,000. Ignoring any timing conventions, that would represent £1,000 per month in the profit calculation.

The cash outflow was £60,000, but the initial monthly cost shown against profit may be only £1,000.

This can create an enormous difference between reported profit and cash movement.

The purchase may still be an excellent decision. The machine might increase capacity, reduce labour costs or create a valuable new revenue stream. But the business must be able to finance the initial expenditure.

This is also why the method of funding matters. Paying £60,000 immediately has a very different short-term cash effect from financing the machine over five years. Finance may increase the total cost through interest, but it can more closely align the cash payments with the period in which the asset generates value.

Profit Can Exist Without Positive Cash Flow

Once these timing differences are combined, it becomes easier to see how a profitable business can experience negative cash flow.

Imagine a business reports a monthly profit of £25,000. During the same month:

• Customer invoices increase by £40,000 because clients have not yet paid.
• The business buys £20,000 of additional stock.
• It makes £8,000 of loan capital repayments.
• It purchases £15,000 of new equipment.
• It pays a VAT liability of £12,000.

The business may genuinely have made a £25,000 profit, but that does not mean its bank balance will increase by £25,000.

Cash has been absorbed by debtors, stock, debt repayments, investment and tax. Without sufficient reserves or external finance, the business may come under pressure despite its reported profitability.

The reverse can also happen.

A business may receive a large customer deposit, draw down a new loan or delay paying suppliers. Its bank balance rises even though it has made a loss.

Positive cash movement does not automatically mean the business is profitable, just as profit does not automatically mean it is generating cash.

Neither Measure Should Be Used in Isolation

I would not choose between profit and cash flow because a well-managed business needs to understand both.

Profitability tells me whether the business model is economically sustainable. If the company repeatedly sells below the cost required to provide its products or services, cash will eventually disappear regardless of how carefully it is managed.

Cash flow tells me whether the business can meet its commitments as they fall due. Even a profitable company can fail if it cannot pay employees, suppliers, lenders or HMRC at the required time.

• Looking only at profit can hide immediate financial pressure.
• Looking only at cash can hide losses, growing liabilities or the temporary effect of borrowing.

The real insight comes from understanding how profit is being converted into cash—and identifying where that conversion is being delayed, diverted or lost.

The most important practical lesson is straightforward:

“A profitable sale only becomes useful cash when the money is collected.”

Until then, the business may have created income and earned a margin, but it is still carrying the cost of the sale. The longer the delay between doing the work and receiving the money, the more cash the business must provide from its own reserves or obtain from someone else.

 

When a profitable business experiences cash flow problems, the immediate assumption is often that something must be wrong with the accounts. If the business is making money, surely there should be money in the bank?

Unfortunately, it does not work that way.

Profit measures whether the business is earning more than it costs to operate. It does not guarantee that the cash will be available when wages, suppliers, tax or loan repayments become due.

In practice, businesses rarely receive money from customers at precisely the same time as they have to pay everyone involved in delivering the work. That gap creates a funding requirement, even when the underlying sale is profitable.

The greater the difference between when the business spends money and when it collects it, the greater the cash flow risk.

Working-Capital Timing Creates the Cash Flow Gap

Working capital is the money a business needs to finance its everyday trading cycle. Most businesses follow some version of this sequence:

1. Buy materials, stock or services.
2. Pay employees or subcontractors.
3. Deliver the product or complete the work.
4. Raise an invoice.
5. Wait for the customer to pay.

Cash normally leaves the business during the early stages of this process. It may not return until much later.

Consider a manufacturer that receives an order worth £150,000. The order is expected to produce a gross profit of £45,000, so commercially it appears attractive. However, the manufacturer must initially spend:

• £60,000 on materials.
• £30,000 on labour.
• £15,000 on other production costs.

That means £105,000 must be found before the customer pays. If the work takes eight weeks to complete and the customer then has 60-day payment terms, the manufacturer could be financing the order for approximately four months.

The eventual £45,000 gross profit does not eliminate that requirement. It only means that, once the entire transaction is completed and the customer has paid, the business should receive more than it spent.

During the intervening period, the business needs £105,000 from its existing cash reserves, supplier credit, customer deposits or external funding.

This is the working-capital gap. “The business is not necessarily unprofitable. Its money is simply committed elsewhere in the trading cycle.”

Growth Can Increase Cash Pressure

Growth is usually treated as the solution to financial difficulty. In reality, rapid growth can be one of the most demanding periods for a business’s cash flow.

A growing company may need to:

• Recruit additional employees.
• Increase subcontractor capacity.
• Buy more stock and materials.
• Take on larger premises.
• Add vehicles or machinery.
• Increase marketing expenditure.
• Invest in new systems.
• Provide customers with credit.

These costs often arise before the additional sales are collected.

Suppose a business currently generates £200,000 of monthly revenue and plans to grow to £300,000. Its customers normally pay 60 days after invoicing, while most of its employees and suppliers must be paid within 30 days.

To support the additional £100,000 of monthly revenue, the business may need to finance two months of increased activity before the first additional receipts arrive.

If the direct cost of delivering those extra sales is £70,000 per month, growth could create an additional working-capital requirement of £140,000 before considering recruitment costs, equipment or increased overheads.

The business may become more profitable as it grows, but its bank balance can deteriorate during the transition.

This is what makes growth particularly dangerous. The management team sees rising revenue, a larger order book and stronger projected profits. Those positive signals can obscure the increasing amount of cash being absorbed.

• A business can therefore grow itself into a cash crisis.
• The faster it grows, the faster it may consume cash.

Slow-Paying Customers Force the Business to Provide the Funding

A customer who pays late does more than create an administrative inconvenience. They increase the amount of money the business must provide to support the sale.

Imagine a company raises £100,000 of invoices every month on 30-day terms.

If customers pay as agreed, the business may consistently have around one month’s revenue tied up in debtors. If the average payment period drifts to 60 days, approximately two months of revenue may be outstanding.

• The company now has an additional £100,000 trapped in unpaid invoices.
• If payment slips to 75 days, the funding requirement increases further.

Nothing may have changed in the profit and loss account. The business could be reporting the same sales and margins. But the bank balance becomes weaker because the cash conversion cycle has lengthened.

The business still has to pay its own commitments. Employees will not normally wait an additional month because a customer is late. HMRC will not extend a tax deadline because the sales ledger has not been collected. Many suppliers will suspend further deliveries if their invoices are overdue.

The business is therefore placed in a difficult position: it must either use its own reserves or borrow money to compensate for the customer’s delayed payment.

In effect, the customer is financing their business with the supplier’s money.

This also means that late payment has a real financial cost. If the business needs an overdraft or invoice-finance facility to replace the missing cash, interest and fees reduce the margin earned on the sale.

A transaction that looked attractive when it was priced may become much less valuable once the cost of financing the customer is included.

Upfront Project Costs Can Consume Cash Before Any Invoice Is Raised

Project-based businesses are especially exposed because they often incur substantial costs before reaching an invoicing milestone. A company may win a profitable contract but need to pay for:

• Design and planning.
• Materials.
• Site preparation.
• Labour.
• Travel and accommodation.
• Equipment hire.
• Subcontractors.
• Insurance or performance guarantees.

If the contract allows the business to invoice only when a particular stage is completed, all the earlier expenditure must be financed.

Suppose a contractor wins a six-month project worth £500,000 with an expected profit of £100,000.

During the first two months, it incurs £140,000 of costs. The first contractual milestone allows it to raise an invoice for £175,000 at the end of month two, but the customer has 45-day payment terms.

The contractor may need to finance almost three and a half months of project activity before receiving the first meaningful payment.

If the milestone is delayed, the work is disputed or the customer takes longer to approve the invoice, the cash requirement increases again. The project could remain profitable overall while creating serious short-term financial pressure.

This is why I regard the payment schedule as a fundamental part of the commercial agreement. A profitable price is not enough. The contract must also provide a workable route from expenditure to collection.

Deposits, mobilisation payments, staged invoicing and shorter approval periods can reduce the amount of cash the business must commit. Without them, the company may win the work but lack the financial capacity to deliver it safely.

Tax Liabilities Can Make Available Cash Look Stronger Than It Is

Money in the bank is not always money the business can safely spend.

A portion may already be committed to VAT, PAYE, National Insurance or corporation tax.

The difficulty is that these liabilities are often paid after the activity that created them. This creates a period in which the cash remains visible in the bank account even though it effectively belongs elsewhere.

VAT is a common example.

A customer payment may include VAT collected on behalf of HMRC. Unless the business separates or reserves that amount, it can easily become absorbed into normal operating expenditure.

The problem emerges when the VAT return becomes due and the money is no longer available.

Corporation tax can create a similar issue. A profitable year may produce a substantial tax liability, but the payment date occurs later. If the owners see the year-end bank balance as free cash and use it for investment, drawings or dividends without reserving for tax, the company may struggle when the liability falls due.

PAYE and National Insurance create more frequent pressure because they are linked to payroll. A business may be able to pay its employees but then find that it has insufficient cash to pay the related deductions and employer liabilities.

Tax deadlines are generally predictable. Tax crises usually arise not because the liabilities were unknown, but because the cash was never reserved.

A business can therefore appear cash-rich while carrying substantial commitments that have not yet left the account.

Debt Repayments Can Absorb the Cash Generated by Profit

Borrowing can help a business manage working capital, invest in equipment or fund growth. But every borrowing decision creates future cash outflows.

Those outflows include both interest and repayment of the original capital.

The interest reduces reported profit. The capital repayment reduces cash but does not reduce profit in the same way. This distinction can create a significant affordability problem.

Suppose a business generates £120,000 of annual profit before tax. It also has annual loan repayments of £90,000, consisting of:

• £20,000 of interest.
• £70,000 of capital repayment.

The interest will be reflected as a cost in calculating profit. The £70,000 capital repayment will not be shown as a normal operating expense, but the cash must still leave the bank.

The remaining profit may therefore appear sufficient until the business also pays corporation tax, invests in replacement equipment or experiences an increase in debtors.

A profitable company can become over-borrowed when its scheduled repayments absorb too much of the cash generated through trading. This is why I always distinguish between whether a business can obtain finance and whether it can safely service that finance.

A lender’s willingness to provide money does not make the repayments affordable.

The test should be whether operational cash generation provides enough headroom to cover the repayments under realistic conditions, not only when everything goes according to plan.

Owner Drawings Can Remove Cash Faster Than the Business Produces It

A profitable business does not automatically have unlimited capacity to fund its owners’ lifestyles. Money taken from the company may include:

• Salary.
• Dividends.
• Director’s loan withdrawals.
• Reimbursement of personal expenditure.
• Pension contributions.
• Benefits or vehicles.
• Other discretionary payments.

Some of these may form part of the cost structure and some may be paid from profits after tax. But all of them ultimately affect cash. The risk arises when the amount withdrawn is based on reported profit or the visible bank balance rather than genuinely available cash.

Suppose a company reports £150,000 of annual profit. The owners decide to withdraw £100,000 because they believe the business can comfortably afford it.

However, during the same year:

• Debtors increase by £60,000.
• The company makes £25,000 of loan capital repayments.
• It spends £20,000 on equipment.
• Corporation tax of £30,000 becomes payable.

The business has not generated enough cash to support all those commitments and the planned withdrawals.

The owners may have a profitable company, but the profit is tied up in customers, assets and other obligations. Removing £100,000 could force the business to increase borrowing or delay payments to suppliers and HMRC.

This does not mean owners should not take money from their businesses. A business should ultimately reward the people who own it.

But drawings and dividends should reflect cash availability, future commitments and the level of reserves the business needs, not profit in isolation.

Cash Pressure Usually Comes From Several Sources at Once

Businesses rarely run out of money because of one perfectly isolated issue. More often, several manageable pressures combine.

A growing company may recruit additional people, purchase more stock and take on a major project. A large customer then pays late. A VAT quarter falls due. Loan repayments continue, and the owners withdraw money based on the previous year’s profit.

Individually, each decision may appear reasonable.

Together, they can produce a cash requirement far larger than management expected. Consider a business that begins the month with £120,000 in the bank. During the next eight weeks:

• £80,000 is committed to a new project.
• Debtor collections arrive £50,000 later than expected.
• A £35,000 VAT payment falls due.
• Loan capital repayments total £12,000.
• The owners withdraw £20,000.
• Growth increases the monthly payroll by £15,000.

The business has not necessarily stopped making a profit. But the timing and scale of its commitments have placed far more pressure on cash than the opening bank balance suggested.

This is why I do not treat cash flow management as simply watching the bank account. I want to understand the commitments building behind it.

Profitability Is Essential, but It Is Not Protection

A sustainably profitable business is in a much stronger position than an unprofitable one. Profit creates the potential to generate cash, build reserves, repay borrowing and fund future growth. But potential cash and available cash are not the same thing.

Profit can be:

• Tied up in unpaid customer invoices.
• Invested in stock.
• absorbed by work in progress.
• Committed to tax.
• Used to repay borrowing.
• Invested in equipment.
• Withdrawn by owners.

A business remains financially safe only when it understands how much cash its operations require, when that cash will be recovered, and what other commitments must be met in the meantime.

The central lesson is:

“Profitability does not remove cash flow risk because income and expenditure rarely happen at the same time.”

A profitable business can survive a temporary gap when it sees the gap early, understands its cause and has sufficient resources to fund it.

The danger comes when management assumes that profit will automatically turn into cash, and discovers too late that the money is still sitting in unpaid invoices, unfinished work or stock while the bills have already fallen due.

One of the most dangerous questions a business owner can ask is:

“How much money have we got in the bank?”

It sounds sensible, but the answer can be misleading. The balance shown by the banking app tells us how much money is currently sitting in the account. It does not tell us how much of that money has already been promised, committed or reserved for something else.

A business can have £200,000 in the bank and still be only days away from a cash flow problem.

Equally, a business with £30,000 in the bank may be in a perfectly manageable position if it has few immediate commitments and significant customer receipts arriving shortly. The number itself is not enough. I need to understand what sits behind it.

This leads to an important distinction between visible cash and available cash.

Visible Cash and Available Cash Are Not the Same Thing

• Visible cash is the amount currently shown in the bank account.
• Available cash is the amount the business can safely use after allowing for its known commitments and the minimum reserve it needs to operate.

A simplified calculation might look like this:

Available cash = Bank balance – committed payments – protected reserves

If the business has £150,000 in the bank but £110,000 is already needed for tax, payroll, suppliers and loan repayments, it does not really have £150,000 available.

It has £40,000, and even that may not be entirely safe to spend if it needs to retain a minimum operating reserve.

This distinction matters because business decisions are often made using visible cash.

A director sees a strong bank balance and decides that the company can afford a new vehicle, additional recruitment, an increased dividend or an early repayment of borrowing. The decision may appear affordable on the day it is made.

The problem becomes visible several weeks later, when the VAT payment, payroll and supplier run all fall due.

The bank balance was not wrong. It was simply incomplete.

VAT May Be in Your Bank Account, but It Is Not Your Money!

VAT is one of the clearest examples of visible cash creating false confidence.

Suppose a business receives £120,000 from customers during the month. If those sales were subject to VAT at 20%, part of the money collected represents VAT rather than income belonging to the business.

The precise amount payable to HMRC will depend on the VAT charged to customers, the VAT recoverable on eligible purchases and the business’s VAT accounting scheme. But the essential principle remains the same: some of the money received may already be owed to HMRC.

If the business spends the VAT element on wages, stock, equipment or owner withdrawals, it has not created additional resources. It has used cash that will need to be replaced when the VAT return becomes payable.

This can be particularly deceptive in a growing business.

As sales increase, customer receipts become larger, and the bank balance may rise. At the same time, the future VAT liability may also be increasing. Unless management distinguishes between the two, apparent cash growth can be mistaken for improved financial strength.

I prefer to treat expected VAT as committed cash rather than part of the operating balance. Some businesses do this by transferring an estimated amount into a separate bank account. Others maintain a reliable forecast showing the liability and payment date. The mechanism matters less than the discipline. 

“The business should never discover what it owes only when the VAT return is submitted.”

PAYE and National Insurance Are Already Committed

Payroll creates more than the net wages paid to employees.

A company may deduct income tax, employee National Insurance and other amounts through payroll. It may also incur employer National Insurance, pension contributions and other employment-related liabilities.

Some of those amounts remain in the bank account temporarily, but they are not available for general use.

They are due to HMRC, pension providers or other parties.

Suppose the company’s payroll records show:

• £70,000 of net wages.
• £22,000 of PAYE and National Insurance due to HMRC.
• £5,000 of pension contributions.
• £3,000 of other payroll-related commitments.

Paying £70,000 to employees does not complete the payroll cash requirement. A further £30,000 is still committed.

If management looks at the bank balance immediately after paying the net wages, it may believe the major cash outflow has passed. In reality, a substantial part of the payroll obligation remains outstanding.

This becomes especially dangerous when a business falls into the habit of using PAYE money as temporary working capital. The following month’s receipts are then needed to settle the previous month’s liabilities, while also funding the current payroll.

The business begins operating one step behind. A single late customer payment can then create a crisis because there is no longer any margin for error.

Corporation Tax Can Be Invisible for Months

Corporation tax presents a different challenge because the liability builds as the company earns profit, but the payment is usually made later.

A successful year can therefore leave a business with a strong bank balance and a significant tax commitment that has not yet been paid.

Imagine a company expects to make a taxable profit of £300,000. Subject to the applicable tax rules, reliefs and rates, that profit could create a substantial corporation tax liability.

The cash may remain visible in the bank for months before the payment date.

During that period, the owners might decide to:

• Pay a dividend.
• Purchase new equipment.
• Recruit additional employees.
• Repay borrowing.
• Move to larger premises.
• Use the cash as a deposit for an acquisition.

Each decision may be commercially reasonable. But if management has not reserved for corporation tax, the same money is effectively being allocated twice.

It is being treated as available for investment while also being required for tax.

I prefer to recognise corporation tax as the profit is earned, rather than waiting for the accounts to be completed. The estimate will change as actual results become clearer, but an informed provision is far safer than pretending the liability does not exist until the tax return is prepared.

“A future payment does not become less real because it is several months away.”

The Next Payroll May Already Belong to Your Employees

Payroll is one of the least flexible cash commitments in most businesses.

Employees expect to be paid in full and on time. A failure to do so can immediately damage trust, morale and retention. It can also signal that the business is in serious financial difficulty.

This means that part of today’s bank balance may already be needed for the next payroll run.

Suppose a company has £95,000 in the bank on the tenth day of the month. Its next payroll, including employment taxes and pensions, will require £80,000. Customer receipts of £120,000 are expected before payday.

On the surface, the position may look comfortable.

But what happens if a major customer delays a £60,000 payment? What if an invoice is disputed? What if the receipt arrives two days after payroll rather than two days before it?

The company’s practical cash headroom is much smaller than the banking app suggests.

When assessing available cash, I therefore consider not only amounts that are legally due today but also unavoidable commitments falling due before the next reliable cash inflow.

A payment does not need to be overdue before it becomes relevant to a cash decision.

Supplier Money May Only Be Passing Through the Account

A high bank balance can also result from timing differences between customer receipts and supplier payments.

Suppose a contractor receives £250,000 from a customer for a completed project. The bank balance increases substantially.

However, £170,000 of supplier and subcontractor invoices relating to the project are due over the next three weeks.

The contractor has not suddenly gained £250,000 of spending capacity. Much of the receipt is simply passing through the business on its way to the people who helped deliver the project. If management commits the money elsewhere before paying those suppliers, it creates a future shortage.

The same issue arises when invoices have been received but have not yet reached their payment date. Because the money remains in the bank, it feels available. Commercially, however, it has already been committed.

Delaying supplier payments can temporarily improve the bank balance, but it does not create cash. It transfers the pressure to creditors. 

This can lead to:

• Suppliers placing accounts on hold.
• Loss of early-payment discounts.
• Reduced credit terms.
• Refusal to provide materials for future work.
• Personal guarantees being requested.
• Damage to the business’s reputation.
• Key suppliers prioritising other customers.

Supplier credit is a legitimate part of working-capital management, but it should be agreed and controlled. It should not depend on ignoring payment dates until suppliers begin chasing.

Customer Deposits Can Create the Strongest False Confidence

Customer deposits are particularly misleading because they bring cash into the business before all the related costs have been incurred. Suppose a company receives a £100,000 deposit for a major project. The bank balance improves immediately. But the money has not necessarily been earned, and it certainly is not all profit.

The deposit may be needed to pay for:

• Materials.
• Labour.
• Subcontractors.
• Design work.
• Equipment hire.
• Delivery.
• Installation.
• Rectification work.
• Refunds if the project cannot proceed.

The business has also taken on an obligation to deliver something in return.

If the deposit is used to fund unrelated overheads, previous projects or owner withdrawals, the company may lack the resources needed to complete the work for which the money was received.

This creates a form of hidden borrowing from the customer.

The danger grows when a business repeatedly uses new deposits to complete earlier jobs. The bank account may continue to show activity, but the company is becoming dependent on future sales merely to meet existing obligations.

It is similar to running downhill: the business can continue while new money arrives, but it becomes increasingly difficult to stop without falling over.

I therefore want to understand how much of every deposit is genuinely available after allowing for the full cost of fulfilling the associated commitment.

A deposit improves liquidity. It does not automatically increase wealth.

Loan Proceeds Are Cash, but Loan Repayments Are Commitments

When a business receives a loan, the full amount appears in the bank account.

A £200,000 loan creates £200,000 of visible cash.

It does not create £200,000 of profit, and it does not mean the business is £200,000 better off. The company has received an asset (cash) and taken on a corresponding liability.

That liability will create future interest and capital repayments.

Suppose the business uses the loan to purchase machinery expected to improve productivity. That may be a sound investment. But part of future operational cash flow is now committed to servicing the borrowing.

When I assess available cash, I therefore consider the repayment schedule as well as the current balance.

A company might hold £80,000 in the bank while facing monthly loan and asset-finance payments of £18,000. If operational cash flow is weak, that balance could disappear quickly.

The issue is not whether the business has cash today. It is how much of its future cash generation has already been promised to lenders.

This is also why unused lending facilities should not be confused with business strength. An overdraft or revolving credit facility can provide valuable protection, but using it creates debt, cost and future dependence.

Borrowing increases immediate liquidity. It does not remove the need for the underlying business to generate cash.

Several Commitments Can Fall Due at the Same Time

The greatest pressure usually arises when several individually predictable payments coincide.

Consider a business with £180,000 in the bank. Its directors believe the company has sufficient cash to invest £50,000 in a new system. However, within the next four weeks, the business must pay:

• £35,000 of VAT.
• £28,000 of PAYE and National Insurance.
• £75,000 of payroll.
• £40,000 to suppliers.
• £8,000 of loan repayments.

Those commitments total £186,000.

The company is already £6,000 short before purchasing the system, even though its bank account initially showed £180,000.

Customer receipts may arrive before all the payments fall due, but that introduces another question: how certain are those receipts?

If they are based on invoices that have not yet been approved, customers with a history of paying late or sales that have not yet been completed, they should not be treated with the same confidence as cash already in the account.

Available cash is therefore not a fixed number. It depends on both the commitments the business must meet and the reliability of the receipts expected before those commitments fall due.

A Credit Balance Can Conceal Financial Stress

Another danger is assuming that a positive balance means the business is financially secure.

A company may keep its bank account positive by:

• Delaying supplier payments.
• Using VAT or PAYE money.
• Drawing down loans.
• Receiving deposits for future work.
• Reducing stock purchases.
• Postponing necessary investment.
• Asking owners to inject additional funds.

The bank balance remains above zero, but the underlying pressure continues to build. For example, a company with £50,000 in the bank may also have:

• £90,000 of overdue supplier invoices.
• £25,000 due to HMRC.
• £20,000 of loan repayments approaching.
• A £60,000 payroll requirement.
• Customers owing £200,000, much of it overdue.

The positive balance does not make the business comfortable. It may simply mean that some creditors have not yet been paid. This is why I would never judge cash health from the bank balance alone. I want to see the commitments, overdue amounts, expected receipts and timing of each movement.

The bank balance is one piece of evidence, not the conclusion.

How I Would Calculate a More Meaningful Cash Position

A more useful cash review begins with the current cleared bank balance and then considers what is already committed.

For example:

Cash position	Amount
Current bank balance	£220,000
Less: VAT reserve	(£32,000)
Less: PAYE and pension liabilities	(£24,000)
Less: corporation tax reserve	(£38,000)
Less: next payroll requirement	(£70,000)
Less: suppliers due before expected receipts	(£28,000)
Less: loan repayments due	(£6,000)
Available cash before minimum reserve	£22,000

The business can see £220,000 in the bank, but only £22,000 remains after known commitments.

If management wants to maintain a minimum operating reserve of £50,000, the company does not have surplus cash at all. It is £28,000 below its preferred safety level.

This is a very different conclusion from looking at the banking app and deciding that £220,000 represents spending capacity.

The calculation does not need to be perfect to be useful. Some liabilities will be estimates, and expected customer receipts may alter the timing. What matters is recognising that the visible balance has multiple competing claims against it.

Available Cash Must Include a Safety Margin

Even after deducting known commitments, I would not assume that every remaining pound can safely be spent.

Businesses need headroom for uncertainty.

Customers may pay late. Equipment can fail. A project can overrun. A supplier may request payment earlier than expected. A tax estimate can increase. Sales can temporarily weaken.

A business operating with no cash reserve is relying on every assumption proving correct. That is not cash management. It is hope.

The appropriate reserve will vary according to:

• The predictability of revenue.
• Customer payment behaviour.
• The size and timing of payroll.
• The reliability of forecasts.
• The availability of borrowing facilities.
• Customer concentration.
• Seasonality.
• The level of fixed costs.
• The risk of unexpected expenditure.

A business with contracted monthly income and low fixed costs may require less headroom than a project-based company with volatile receipts and a large weekly payroll.

The objective is not to hoard cash unnecessarily. It is to retain enough flexibility to absorb normal disruption without immediately delaying payments or seeking emergency funding.

The Better Question Is Not “What Is in the Bank?”

When reviewing cash, I would replace one question with a series of more useful ones.

Instead of asking: How much is in the bank?

I would ask:

• How much of the balance is already committed?
• What must be paid before the next reliable customer receipts arrive?
• Which expected receipts are genuinely dependable?
• How much belongs to HMRC, employees, suppliers or customers?
• What loan repayments are approaching?
• What minimum reserve should the business retain?
• How much cash remains after all of those claims are recognised?

These questions convert the bank balance from a number into a decision-making tool. They also reduce the risk of spending the same money twice, once on a new decision and again on the obligation it was already needed to meet.

The standalone lesson is simple:

The bank balance shows what is in the account, not what the business can safely spend.

Visible cash may create comfort. Available cash provides the truth. The difference between the two is where many cash flow problems begin.

Working capital is the money a business needs to finance its everyday operations. It pays for the gap between spending money to deliver a product or service and receiving payment from the customer.

This gap exists because most businesses do not buy, sell, collect and pay for everything on the same day. Materials may be purchased weeks before a product is sold. Employees must be paid before a customer settles an invoice. Stock can sit in a warehouse for months. A project may be substantially complete before the business is entitled to bill for it. The business must finance each of these stages.

When I examine working capital, I am trying to understand three things:

• Where the business’s cash is becoming trapped.
• How long it remains trapped.
• Who is financing the gap while the business waits to recover it.

A profitable business with poor working-capital control can experience constant cash pressure. A business with strong control can often grow further, respond faster and operate with less borrowing.

The Traditional Definition of Working Capital

In accounting terms, working capital is usually calculated as:

Current assets – current liabilities

Current assets are amounts expected to be converted into cash, sold or used within the normal operating cycle. They commonly include:

• Cash.
• Trade debtors.
• Stock.
• Work in progress.
• Other short-term amounts owed to the business.

Current liabilities are amounts expected to be paid within the short term. They commonly include:

• Trade creditors.
• Tax liabilities.
• Accruals.
• Short-term borrowing.
• Other amounts due within the next year.

This calculation provides a broad indication of short-term financial strength, but the total alone does not tell me enough.

Two companies may report identical working capital while facing very different risks.

One may hold most of its current assets as cleared cash. The other may have the same amount tied up in old stock and overdue customer invoices that are becoming difficult to collect. The accounting value may be similar. The practical value is not.

I therefore look beyond the total and examine the main components individually.

Debtors: Money Earned but Not Yet Collected

Debtors (often called trade debtors or accounts receivable) are customers who owe the business money. The business has delivered a product or service and raised an invoice, but the cash has not yet arrived.

Suppose a company invoices £200,000 during the month. Its customers receive 30-day payment terms.

If everyone pays exactly on time, the business may have around £200,000 tied up in debtors at any one point. That is approximately one month’s sales waiting to be converted into cash.

If customers begin paying after 60 days, the debtor balance could rise towards £400,000. The business has not necessarily made any additional sales. It simply has to wait twice as long to receive the money. That extra £200,000 must be financed from somewhere.

The company might use:

• Existing cash reserves.
• An overdraft.
• Invoice finance.
• Extended supplier credit.
• Owner investment.
• Money that should have been reserved for tax.
• Delayed investment or owner withdrawals.

This is why debtor control is much more than a bookkeeping function. Every overdue invoice represents cash the business has earned but cannot yet use. I also distinguish between the value of the debtor ledger and its quality.

A £500,000 debtor balance may look valuable, but I want to know:

• How much is within agreed payment terms?
• How much is overdue?
• Are any invoices disputed?
• Do the customers have the ability to pay?
• Is the supporting documentation complete?
• Is too much owed by one customer?
• How quickly is the balance being collected?
• Is any of it unlikely to be recovered?

A debtor only supports the business when it turns into cash.

Debtor Days Show How Long the Business Waits

Debtor days provide a useful measure of the average time customers take to pay.

A simplified calculation is: Trade debtors ÷ annual credit sales × 365

If a business has £300,000 of trade debtors and annual credit sales of £3 million, its approximate debtor period is: 

£300,000 ÷ £3,000,000 × 365 = 36.5 days

The exact calculation can be affected by VAT, seasonality and changes in revenue, but it provides a useful indicator. More important than the isolated number is the trend.

If debtor days rise from 36 to 50, the business is taking two weeks longer to turn its sales into cash.

On annual credit sales of £3 million, those additional 14 days represent approximately £115,000 more cash tied up in customers:

£3,000,000 ÷ 365 × 14 = approximately £115,000

The profit margin has not necessarily changed. But the business now needs to find another £115,000 to support the same level of sales.

“A small change in collection time can therefore create a significant funding requirement.”

Stock: Cash Waiting to Become a Sale

Stock includes the goods and materials a business holds for sale or intends to use in production.

It might consist of:

• Raw materials.
• Components.
• Finished goods.
• Consumables.
• Spare parts.
• Products purchased for resale.

Stock is necessary in many businesses. Without sufficient stock, the company may be unable to satisfy customers, maintain production or respond quickly to demand.

But stock also absorbs cash.

The business pays a supplier and receives goods rather than money. The cash cannot return to the bank until the stock is sold and the customer pays. Suppose a wholesaler purchases £250,000 of stock. 

• If it sells the stock within 30 days and collects from customers shortly afterwards, the cash turns over relatively quickly.
• If the stock remains unsold for six months, the same £250,000 is unavailable for payroll, tax, marketing, investment or other purchases throughout that period.

The stock may still appear as an asset in the accounts, but that does not mean it is financially harmless. Some stock may also:

• Become damaged.
• Go out of date.
• Become technically obsolete.
• Fall out of fashion.
• Require discounting.
• Be held for products customers no longer want.
• Exist in the records but not in the warehouse.

I therefore ask not only how much stock the business holds, but why it holds it and how quickly it moves. Too little stock can reduce sales and damage service. Too much stock can make the business appear asset-rich while leaving it cash-poor.

Good stock management is a balance between operational resilience and financial efficiency.

Stock Days Measure How Long Cash Remains on the Shelf

Stock days estimate how long stock is held before being sold or used.

A common calculation is: Average stock ÷ annual cost of sales × 365

Suppose a business holds average stock of £400,000 and has annual cost of sales of £2 million:

£400,000 ÷ £2,000,000 × 365 = 73 days

This suggests that the company holds approximately 73 days of stock.

If it can reduce this to 55 days without damaging sales or operations, it could release approximately £99,000 of cash:

£2,000,000 ÷ 365 × 18 days = approximately £99,000

That cash has not come from a new loan or additional sale. It has been released from the company’s existing operations.

However, I would not pursue a lower stock figure blindly. If reducing stock causes missed orders, production delays or expensive emergency purchases, the apparent cash benefit could destroy value elsewhere.

“The objective is not minimum stock. It is the right stock, in the right quantity, moving at the right speed.”

Work in Progress: Cash Tied Up in Unfinished or Unbilled Work

Work in progress is especially important in construction, manufacturing, engineering, professional services and other project-based businesses. It represents work that has begun but has not yet reached the point at which it is completed, sold or fully invoiced.

The business may already have incurred:

• Labour costs.
• Subcontractor charges.
• Materials.
• Travel and accommodation.
• Equipment hire.
• Design costs.
• Site costs.
• Project overheads.

Until the work is invoiced and collected, the business is financing those costs.

Suppose a contractor spends £40,000 each month on a project but is only permitted to invoice when it reaches a milestone at the end of month three.

By that point, it has invested £120,000 in the project.

If the customer then has 30-day payment terms, the contractor may need to finance another month before receiving the money. The project could require £160,000 of working capital before the first major receipt arrives.

If the milestone is delayed, the invoice requires approval, or the customer disputes part of the work, the cash remains trapped for longer.

Work in progress can become particularly dangerous when it is poorly measured. Management may believe projects are progressing normally while costs accumulate without a clear route to invoicing.

I want project reporting to show:

• Costs incurred to date.
• Work completed.
• Amounts invoiced.
• Amounts collected.
• Work not yet invoiced.
• The next billing milestone.
• Expected approval and payment dates.
• Remaining cost to complete.
• Any overruns or disputes.

Work in progress is not merely an accounting adjustment. It is money the business has already spent and is trying to recover.

Creditors: Suppliers Helping to Finance the Business

Creditors, often called trade creditors or accounts payable, are suppliers the business owes money to.

Supplier credit can help finance the working-capital cycle.

If a supplier provides materials today but allows the business 30 days to pay, the company does not have to fund the purchase immediately. It has time to use the materials, complete the work or potentially collect from its own customer before paying the supplier.

Suppose a business purchases £100,000 of materials on 60-day terms and sells the completed product for cash within 30 days.

The customer’s money arrives before the supplier needs to be paid. The supplier has effectively helped finance the operating cycle. This is one reason some businesses can grow with relatively little external funding.

But supplier credit is not free money.

The business still owes the amount, and its ability to use that credit depends on maintaining trust and paying according to the agreed terms.

Delaying suppliers beyond their due dates may temporarily improve the bank balance, but it can create serious consequences:

• Accounts may be placed on hold.
• Deliveries may stop.
• Credit limits may be reduced.
• The business may lose negotiated discounts.
• Suppliers may demand payment in advance.
• Key commercial relationships may be damaged.
• Future projects may become harder to deliver.

There is an important difference between using agreed supplier terms and failing to pay suppliers because the business does not have the cash. The first is working-capital management. The second is financial distress.

Creditor Days Show How Long the Business Takes to Pay

Creditor days estimate the average time the business takes to pay its suppliers.

A simplified calculation is: Trade creditors ÷ annual credit purchases × 365

If trade creditors are £250,000 and annual credit purchases are £2.5 million:

£250,000 ÷ £2,500,000 × 365 = 36.5 days

As with debtor and stock days, the trend matters.

An increase in creditor days may indicate that the business has negotiated better payment terms. That could be a positive improvement. But it may also indicate that the company is delaying suppliers because it lacks cash. The same number can tell two very different stories.

I would therefore want to know whether:

• Longer terms have been formally agreed.
• Supplier invoices are genuinely disputed.
• The business is paying strategically or merely reacting to pressure.
• Essential suppliers are being protected.
• Overdue balances are increasing.
• Credit limits remain adequate.
• Suppliers are threatening to suspend service.

Creditor days should be interpreted alongside the payment record and supplier relationships. not celebrated simply because the number has increased.

The Working-Capital Cycle

The working-capital cycle describes the journey cash takes through the business.

For a product-based company, the cycle might be:

1. Cash is paid to a supplier.
2. Materials or stock are received.
3. Stock is held or converted into a finished product.
4. The product is sold.
5. The customer is invoiced.
6. The business waits for payment.
7. Cash returns to the bank.

For a project-based service business, the cycle might be:

1. Employees and subcontractors begin work.
2. Materials and site costs are incurred.
3. Work in progress builds.
4. A contractual milestone is reached.
5. The customer approves the work.
6. An invoice is raised.
7. The customer pays.
8. Cash returns to the business.

The cycle begins when the business commits cash and ends when it recovers that cash from the customer. The longer the cycle, the more working capital the business requires. The amount of cash tied up is affected by three main time periods:

• How long stock or work in progress is held.
• How long customers take to pay.
• How long the business has before paying suppliers.

A simplified cash conversion cycle can be expressed as:

Stock or work-in-progress days + debtor days – creditor days

Suppose a manufacturer holds stock for 50 days, waits 45 days for customers to pay and pays suppliers after 30 days:

50 + 45 – 30 = 65 days

The business must finance approximately 65 days of its operating cycle.

If annual operating costs subject to that cycle are £3.65 million, the average daily cost is approximately £10,000.

A 65-day cycle could therefore represent around £650,000 of cash tied up in operations.

That is why apparently modest changes in timing matter so much. Reducing the cycle by ten days could potentially release around £100,000 of cash.

A Simple Working-Capital Scenario

Consider a contractor that wins a project for £120,000 plus VAT. The direct cost of delivering the work is expected to be £80,000, creating a gross profit of £40,000 before overheads.

The project takes two months to complete. During the first month, the contractor pays:

• £25,000 to employees and subcontractors.
• £20,000 for materials.
• £5,000 for equipment hire and other project costs.

The first month therefore creates a £50,000 cash outflow. During the second month, the contractor pays:

• £20,000 to employees and subcontractors.
• £8,000 for additional materials.
• £2,000 for other costs.

A further £30,000 leaves the business. By completion, the contractor has spent the full £80,000 cost of delivering the project.

The contract allows the company to invoice only on completion. The customer takes one week to approve the work, after which the invoice is raised on 30-day terms. The customer then pays ten days late.

The timing looks like this:

Stage	Cash movement	Cumulative cash position
Month one project costs	(£50,000)	(£50,000)
Month two project costs	(£30,000)	(£80,000)
Approval and payment period	£0	(£80,000)
Customer payment received	£120,000	£40,000

The project ultimately produces £40,000 of gross profit before overheads.

But the contractor must finance a maximum cash requirement of £80,000 and wait beyond completion before recovering it.

“The project is profitable, but it is not self-funding.”

If the contractor wins four similar projects at the same time, it could need £320,000 of working capital. That is the risk growth creates. The business may have £480,000 of future revenue and £160,000 of expected gross profit, yet still be unable to finance delivery.

A strong order book does not pay for the work required to complete it.

Better Payment Terms Can Transform the Same Project

Now consider the same £120,000 contract with a different payment structure:

• A 25% deposit when the contract is signed.
• A 40% stage payment at the end of month one.
• The remaining 35% invoiced on completion.

The business receives £30,000 before work begins.

At the end of month one, it invoices £48,000. If that invoice is paid promptly, the business has received £78,000 by the time most of the costs have been incurred.

The final £42,000 becomes payable on completion.

The total price and expected profit have not changed. What has changed is the amount of cash the contractor must provide and the length of time it remains exposed.

The customer is now helping to finance the work rather than expecting the contractor to fund the entire project. This illustrates an important principle:

“Payment terms are part of the commercial value of a sale.”

Two contracts with the same price and margin can have entirely different cash consequences.

A slightly lower-margin contract with a deposit and stage payments may be financially stronger than a higher-margin contract that requires the supplier to finance every cost for several months.

Cash Conversion Measures How Efficiently Profit Becomes Cash

Cash conversion describes how effectively a business turns its reported profit or trading activity into actual cash.

A business with strong cash conversion collects customers promptly, controls stock and work in progress, invoices without delay and uses supplier terms appropriately.

A business with weak cash conversion may report profit while continually absorbing cash.

A simplified cash conversion measure can compare operating cash generated with operating profit:

Operating cash generated ÷ operating profit × 100

If a business reports £500,000 of operating profit and generates £450,000 of operating cash, its cash conversion is approximately 90%.

If it reports the same £500,000 profit but generates only £100,000 of cash, conversion is just 20%.

That does not automatically mean the second business is failing. It may be investing in stock or supporting a temporary period of growth.

But it tells me that £400,000 of the reported profit has not yet appeared as operating cash. I need to understand where it has gone.

Possible explanations include:

• Debtors have increased.
• Stock has increased.
• Work in progress has increased.
• Suppliers have been paid more quickly.
• Customer deposits have reduced.
• Previously delayed liabilities have now been settled.
• Some reported income has not yet been collected.

Cash conversion is most useful as a trend rather than a one-off percentage.

A single weak period may have a reasonable explanation. Repeatedly weak conversion suggests that the business is struggling to turn its accounting performance into usable cash.

Negative Working Capital Is Not Always Bad

It is easy to assume that every business should hold large positive working capital. That is not necessarily true. Some business models collect cash from customers before paying suppliers. A supermarket, for example, may sell goods to customers immediately while receiving credit terms from its suppliers. A subscription business may receive annual payment in advance before delivering the service over the following year.

These businesses can operate with low or even negative working capital because customers and suppliers help finance the operating cycle.

That can be a significant commercial advantage.

However, the model depends on the cash timing remaining favourable. If customer behaviour changes, supplier terms shorten or advance receipts are spent before the related obligations are fulfilled, the apparent advantage can quickly become a risk.

Negative working capital can indicate an efficient operating model, or a business that is failing to pay its liabilities.

Once again, the number does not tell the entire story. I need to understand why it exists.

Working Capital Determines How Much Growth the Business Can Afford

A business does not grow only according to the amount of work it can win. It also grows according to the amount of work it can finance.

Suppose each additional £1 of monthly revenue requires:

• 40 pence of stock or project costs before invoicing.
• 30 pence of labour and overhead before collection.
• A 60-day wait for customer payment.
• Only 30 days of supplier credit.

Rapid sales growth will increase the cash tied up in the cycle.

Unless margins, deposits, payment terms or available funding improve, the company may eventually reach a point where it cannot afford to accept more profitable work.

That is why I see working-capital capacity as part of business capacity.

A company may have the people, customers and technical ability to double its revenue. But if it cannot finance the additional debtors, stock and work in progress, the growth plan is incomplete.

How a Business Can Improve Working Capital

Improving working capital does not always require dramatic cost cutting or new borrowing. The business can often release cash by improving the speed and discipline of its existing processes. Practical actions include:

• Requesting customer deposits.
• Using stage or milestone billing.
• Raising invoices immediately.
• Making invoice requirements clear before work begins.
• Resolving disputes quickly.
• Following up debts before they become seriously overdue.
• Reviewing customer credit limits.
• Reducing unnecessary stock.
• Identifying slow-moving or obsolete stock.
• Monitoring unbilled work in progress.
• Shortening project approval processes.
• Negotiating appropriate supplier terms.
• Scheduling payments according to agreed dates.
• Matching major purchases to customer demand.
• Pricing contracts to reflect their funding requirement.

Each improvement reduces either the amount of cash entering the cycle or the time it remains trapped.

The greatest working-capital improvements often come from coordination across the business.

Sales agrees the payment terms. Operations controls stock and project delivery. Finance raises invoices and collects debts. Purchasing negotiates supplier terms. Management decides how much cash can be committed.

If each function operates separately, the business can win profitable work with payment terms it cannot afford, purchase stock it does not need or complete work that remains unbilled.

Working capital is therefore not solely the responsibility of the finance team. It is the financial consequence of decisions made throughout the business.

The Working-Capital Questions I Would Ask

To understand a company’s position, I would ask:

• How long does it take to invoice after completing the work?
• How quickly do customers actually pay?
• How much of the debtor ledger is overdue or disputed?
• How much stock is held, and how quickly does it move?
• How much cash is tied up in unbilled work in progress?
• When can projects first be invoiced?
• Are supplier terms being used deliberately?
• Are creditors paid according to agreed terms or only when they chase?
• How much additional working capital would further growth require?
• Is the business generating cash from operations or depending on new borrowing?
• Could deposits, staged billing or revised contract terms reduce the funding gap?

These questions tell me far more than the year-end working-capital figure alone.

They reveal how the business converts its activity into cash.

The central lesson is:

“Working capital is the cash trapped between delivering the work and getting paid for it.”

The business may eventually recover that cash and earn a good profit. But until the customer pays, someone must finance the gap.

The better a business controls that cycle, the less cash it needs to tie up, the less dependent it becomes on borrowing and the more safely it can grow.