The overdraft that grew while profit grew
Meridian Retail Ltd has just presented its 2025 accounts to its bank. Revenue rose from £4.00m to £4.80m and gross profit from £1.32m to £1.44m, yet the bank manager is uneasy: the overdraft has grown by £400,000 in a year in which the company reported a profit. Extracts (year end 31 December):
| 2025 | 2024 | |
|---|---|---|
| Inventories | £840,000 | £600,000 |
| Trade receivables | £1,050,000 | £700,000 |
| Trade payables | £600,000 | £500,000 |
| Bank | £50,000 overdrawn | £450,000 positive |
Cost of sales was £3,360,000 in 2025 and £2,680,000 in 2024. All sales and purchases are on credit, and the year has 365 days.
1. Calculate inventory days, receivable days, payable days and the length of the working capital cycle for both years, and interpret the movement.
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2025
- Inventory days = 840/3,360 × 365 = 91.3 days
- Receivable days = 1,050/4,800 × 365 = 79.8 days
- Payable days = 600/3,360 × 365 = 65.2 days
- Cycle = 91.3 + 79.8 − 65.2 = 105.9 days
2024
- Inventory days = 600/2,680 × 365 = 81.7 days
- Receivable days = 700/4,000 × 365 = 63.9 days
- Payable days = 500/2,680 × 365 = 68.1 days
- Cycle = 81.7 + 63.9 − 68.1 = 77.5 days
Interpretation. The cycle has lengthened by about 28 days. Every element has moved the wrong way: stock is held three weeks longer, customers pay roughly 16 days slower, and suppliers are paid three days faster, so the company is financing both its shelves and its customers. At a cost of sales of £3.36m, each day of the cycle absorbs about £9,200, so the 28-day deterioration ties up roughly £260,000 of extra funding. Slower receivable collection is the most worrying element because it is the least visible in the income statement.
2. The directors argue that 'profit more than doubled the cash problem'. Reconcile the movement in the bank balance with the trading results, quantifying each element you can identify.
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Margin. Gross margin fell from 33.0% (1,320/4,000) to 30.0% (1,440/4,800). At the old margin, 2025 revenue of £4.80m would have produced £1,584,000 of gross profit. The company therefore gave away about £144,000 of margin to buy volume - gross profit rose by only £120,000 on a 20% increase in sales.
Working capital absorbed:
| Movement | £ |
|---|---|
| Inventories increase | (240,000) |
| Receivables increase | (350,000) |
| Payables increase | 100,000 |
| Net absorption | (490,000) |
The overdraft rose by £400,000 while £490,000 was absorbed by working capital. That means the company generated no surplus at all from trading after financing its own growth: the residual £90,000, plus any tax, drawings, interest and capital expenditure, had to be met from somewhere else. The essential point is that the profit shown is real but is not cash - it is locked in stock and in unpaid customer invoices. Sales growth funded by looser credit is not self-financing.
3. Which single figure would you ask for next, and what would make you doubt the quality of the reported revenue?
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Ask for the aged receivables analysis and the post-year-end cash receipts book. Receivable days have moved from 64 to 80 in one year, which is the largest proportionate deterioration of the three ratios. An ageing will show whether the increase is spread thinly (a genuine change in customer mix or terms) or concentrated in a few accounts (a collection failure or a doubtful debt problem). Post-year-end receipts will show whether the year-end balances are real cash or whether credit notes and returns follow shortly after the year end.
Doubt is raised where: a large share of the increase sits in the final quarter; the same few customers account for the growth in revenue and receivables; the sales are to new customers on extended terms; or goods are shipped just before the year end. Each of these is a classic indicator that revenue has been recognised ahead of the underlying cash-generating activity, which would make the profit figure - not merely the overdraft - the real issue.