Halvard Building Supplies: Profit Without Cash

Profit and cash are different measurements: profit records transactions when they are earned or incurred, cash records them when money moves. Four mechanisms explain the gap.

1. Working-capital absorption. Calculate the cash cycle from the year-end balances (cost of sales = 69% × 6.8m = USD 4.692m):

• Receivables: 1.45 ÷ 6.8 × 365 = 78 days
• Inventory: 1.23 ÷ 4.692 × 365 = 96 days
• Payables: 0.41 ÷ 4.692 × 365 = 32 days
• Cash cycle = 78 + 96 − 32 = 142 days

A 142-day cycle means cash is committed for almost five months before it returns. If revenue grew during the year, receivables and inventory grew with it, and that growth consumed cash that never appears as an expense - it appears as a balance-sheet increase.

2. Capital expenditure. USD 260,000 spent on vehicles is not an expense; only depreciation enters the income statement. The cash, however, left in full. Profit therefore overstates operating cash by roughly the net book value added.

3. Financing and distributions. Dividends of USD 120,000 and loan repayment of USD 75,000 are pure cash outflows with no effect on profit at all. Together they exceed a quarter of reported profit.

4. Timing. The contractor now paying 60 days late stretches receipts without changing sales.

Reconciliation logic. 412 − 120 (dividends) − 75 (repayment) − 260 (capex) = −43, then the working-capital increase and any tax paid take the overdraft movement to +320. A precise reconciliation needs prior-year balances; the direction and scale are already clear: growth in receivables and inventory, funded by an overdraft, plus capital spending and distributions out of profit.

Receivables: 78 → 45 days. Reduction of 33 days on revenue of USD 6.8m: 33 ÷ 365 × 6.8m = ≈ USD 614,800.

Inventory: 96 → 70 days. Reduction of 26 days on cost of sales of USD 4.692m: 26 ÷ 365 × 4.692m = ≈ USD 334,200.

Payables: 32 → 45 days. Extension of 13 days on cost of sales: 13 ÷ 365 × 4.692m = ≈ USD 167,100 of additional supplier finance.

Total potential release ≈ USD 1,116,100 - more than double the existing overdraft and comfortably larger than the proposed branch cost.

Evaluating achievability.

• Receivables is the biggest prize but the hardest. 38% of credit sales sit with two contractors, one of whom has already moved to 60 days. A blanket 45-day policy will not be observed by a customer with that bargaining power; the practical route is credit insurance or invoice discounting on the contractor ledger, plus staged terms for the remaining 62% of customers. Expect perhaps 15 of the 33 days, not all of it.
• Inventory is the most controllable. 96 days in building materials partly reflects bulk buying and slow-moving lines. Rationalising the bottom 20% of stock lines by turnover is within management's gift and does not require a customer's consent - the most reliable target.
• Payables is the cheapest but carries a cost. Stretching suppliers to 45 days may forfeit settlement discounts. If a 2% discount for 30-day payment is lost, the annualised cost of that finance far exceeds overdraft interest; the extension should target only suppliers with no discount structure.

Conclusion. Sequence inventory first (self-controlled), receivables second (needs customer negotiation and finance tools), payables last (check the discount arithmetic). A realistic near-term release is USD 500,000–600,000.

The case against proceeding now. The overdraft is at USD 410,000 against a USD 450,000 limit - USD 40,000 of headroom. A USD 600,000 branch cannot be funded from that facility at all; it requires new debt or equity. Lenders will price the risk on the existing 142-day cash cycle, and the branch will itself consume working capital before it generates any: stock, fit-out and staff costs precede sales by months. Opening a branch while the core business is technically illiquid is doubling a fragile position.

The case for a conditional approach. The company is profitable (USD 412,000), gross margin is 31%, and the branch is a growth decision, not a rescue. Refusing outright may cede territory to competitors. So the question is sequencing, not yes or no.

Recommended sequence.

1. Months 0–6: fix the cash cycle. Set a receivables target, rationalise inventory, negotiate terms, and install a 13-week rolling cash forecast. Target release of USD 500,000–600,000 as calculated.
2. Months 3–6: renegotiate the facility. Approach the bank with a forecast and a reduced overdraft requirement. A lender that sees the cash cycle closing will lend; one that sees an overdraft at 91% of limit will not.
3. Months 6–9: decide on the branch with real numbers. Prepare a branch appraisal using contribution and payback, not just projected turnover, including the working-capital requirement - which is usually the item that is underestimated.
4. Funding preference. Lease the branch premises rather than buy, preserving capital; fund fit-out from the released working capital rather than new debt, so the covenant and interest cover are unaffected.

Decision rule for the board. Proceed if, and only if, (a) the cash cycle falls below 110 days, (b) the overdraft is below 60% of the limit, and (c) the branch appraisal shows payback within three years including its working-capital absorption. Otherwise defer by twelve months - a delayed branch costs opportunity, a badly funded one costs the company.