Profit without cash at a family furniture manufacturer
Kyriakos runs a family furniture manufacturer with sales of €1.2 million, net profit of €90,000, and a €100,000 overdraft that is fully drawn. Trade receivables are €246,000 (75 days), inventory €197,000 (60 days), and payables €99,000 (30 days). The bank charges 7% on the overdraft and has asked for a cash-flow forecast before increasing the limit. A major retailer, representing 25% of sales, asks to extend payment from 30 to 90 days in exchange for a 3% volume increase. The production manager wants to buy €40,000 of stock to obtain a 5% discount. The owner is confused: 'We made a profit, so why is there no cash?'
1. Explain why a profitable business can run out of cash and calculate the cash operating cycle.
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Profit is an accounting measure of revenue minus expenses over a period; cash is the timing of receipts and payments. Credit sales create receivables, and stock purchases consume cash before the goods are sold. Here the cash operating cycle is receivables 75 days + inventory 60 days − payables 30 days = 105 days. The firm waits 105 days between paying for stock and collecting from customers.
With sales of €1.2 million, daily sales are about €3,288; 105 days ties up roughly €345,000. The overdraft is only €100,000 and is fully drawn, so growth widens the gap. The €90,000 profit is not cash if it is locked in receivables and stock. Loan repayments or asset purchases may also reduce cash without appearing as an expense.
Judgement: the business is profitable but illiquid. It needs permanent working capital or a shorter cycle, not merely a larger overdraft. The owner should manage cash separately from profit and forecast weekly.
2. Evaluate the retailer's request to extend terms to 90 days for a 3% volume increase, and the €40,000 stock purchase at a 5% discount.
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Retailer: 25% of €1.2 million = €300,000. A 3% increase adds €9,000, giving €309,000. Extending from 30 to 90 days adds 60 days of receivables: €309,000 × 60/365 ≈ €50,800. At 7%, the financing cost is about €3,556 per year. Contribution on the extra €9,000 at, say, 30% is €2,700 - less than the financing cost, before bad-debt risk. The customer also represents 25% of sales, so concentration risk rises.
Stock: 5% of €40,000 is €2,000 saved. Holding the stock for 60 more days costs about €460 in financing, plus storage and obsolescence. The saving is positive in isolation, but the firm has no cash; using the overdraft may breach the limit.
Judgement: reject the 90-day request unless the retailer pays interest, accepts 60 days, or offers a larger volume increase. Do not buy the discount stock for cash; negotiate supplier credit or consignment instead.
3. Recommend a cash-management action plan for the next 90 days.
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- Prepare a 13-week rolling cash forecast and identify weekly gaps.
- Invoice on the day of dispatch; offer 2% early settlement for 10 days only to selected customers, because 2% for 20 days is expensive annualised.
- Credit-check new customers, set credit limits and stop supply at 60 days overdue.
- Negotiate 45-day payables with key suppliers without damaging supply.
- Reduce inventory by €40,000 through SKU rationalisation; do not buy the discount stock.
- Convert part of the overdraft into a term loan or equity, because the 105-day cycle is permanent working capital.
- Consider factoring receivables; it may cost 2–3% but solves timing.
- Delay non-essential capital expenditure.
Monitor daily bank balance, days sales outstanding, days inventory outstanding and days payables outstanding. Judgement: the priority is structural. A 105-day cycle needs about €345,000; a bigger overdraft alone treats the symptom, not the cause.