Profit, cash and working capital

The P&L and the bank account answer different questions. The P&L asks did we earn more than it cost?; the cash flow asks where did the money come from and where did it go? This page explains, in general terms, why the two differ and how CFO Panorama shows the link. The example is invented; the exact calculations the application uses are in The cash flow statement and Ratios.

Revenue is not cash received

Revenue is recorded when you deliver and invoice — not when the customer pays. An invoice of 100 000 CZK issued on 28 March is March revenue even if the money arrives in May. Until then it sits on the balance sheet as a trade receivable. The same works the other way for costs: a supplier's invoice is a March cost, but the cash leaves when you pay it, and meanwhile it is a trade payable.

Profit is not cash flow

Some costs never move cash in the period: depreciation spreads the price of a machine or a renovation over its useful life, so the cost appears every month while the cash left once, on purchase. Some cash movements never touch the P&L: buying equipment, drawing or repaying a loan, paying a dividend.

The indirect cash flow therefore starts from net profit, adds back the costs that moved no cash, and then corrects for the money tied up in — or released from — receivables, inventory and payables. The investing and financing sections then show the equipment bought and the loans and dividends paid.

Working capital

Working capital is the money tied up in the day-to-day business: receivables and inventory, less what you owe to suppliers. When receivables grow faster than payables, the business is financing its customers, and cash falls even if profit is good. In the application's ratios, working capital is current assets minus current liabilities.

A worked example

An invented company, in thousands of CZK, for one year:

A profit of 100 produced only 20 of cash, mainly because 150 more was waiting to be collected from customers at year end. In CFO Panorama the same story is in the Cash flow tab: the working-capital lines sit between profit and the cash flow from operations, and a click on any of them shows the accounts and postings behind it.

How long cash is tied up

Three ratios turn the balances into days (general idea; the application's exact formulas are listed in Ratios):

• Days sales outstanding (DSO) — how many days of revenue are still unpaid by customers. Average receivables of 300 against annual revenue of 1 200 give 300 × 365 / 1 200 ≈ 91 days.
• Days inventory outstanding (DIO) — how many days of cost of sales sit in stock.
• Days payables outstanding (DPO) — how many days of purchases you still owe.

The cash conversion cycle is DSO + DIO − DPO: the number of days between paying for what you sell and being paid for it. A shorter cycle means less cash tied up for the same business.

Debt and net debt

Profit and cash also differ by how the business is financed. Net debt is financial debt (bank loans, bonds and similar) less cash. The cash flow statement reconciles last year's net debt to this year's: free cash flow reduces it, dividends and new leases increase it. See The cash flow statement.

Good to know

• These measures describe the books as they are. If invoices are posted late or receivables are not cleared when paid, the days and the cash flow are affected too — see Reading the figures with care.
• Ratios computed on a part of a year are annualised by the application where that makes sense; the article on Ratios says which.