Working Capital: Why Profitable Companies Still Run Out of Cash

Here is a scenario that surprises founders every year. The business is profitable. The profit and loss statement is healthy, sales are growing, margins are fine. And yet the bank account is empty and payroll is a genuine worry. Nothing was stolen. Nothing was wasted. The money is simply trapped, and the name for where it is trapped is working capital.

This is not a fringe problem. Small and medium businesses make up over 80% of employment across Africa, yet face an estimated 331 billion dollar financing gap, according to the IFC, and a large part of that squeeze is precisely the working capital that everyday trading and growth demand. Managing it well is one of the few levers that does not depend on an outside cheque.

Understanding this one concept explains more surprise cash crunches than any other in small business finance. It is also the difference between growth that strengthens a company and growth that quietly bankrupts it.

Profit and cash are not the same event

Profit is recorded when you make a sale. Cash arrives when the customer actually pays. Between those two moments, the sale is real profit but not yet real cash. In the meantime you have already paid for the stock, the staff and the delivery.

This is why your accountant can show you a profit while your bank app shows you a problem. They are describing two different things. Profit is a measure of performance over a period. Cash is a fact at a moment in time. A healthy business needs both, and in the short run, cash is the one that keeps the lights on.

Working capital is the cash tied up in the gap between the two. It lives in three places:

• Inventory: money you have spent on stock that has not sold yet.
• Receivables: money customers owe you for sales you have already made.
• Payables: money you owe suppliers but have not paid yet, which works in your favour.

Roughly, the cash trapped in the business is inventory plus receivables minus payables. The first two lock cash up. The third frees it. Manage the three deliberately and you control your own cash. Ignore them and they control you.

The cash conversion cycle

The cleanest way to see the trap is the cash conversion cycle, measured in days. It answers one question: from the moment you pay for stock, how many days until the cash comes back?

Cash conversion cycle = days to sell inventory + days to collect from customers - days you take to pay suppliers

Work through a trading business:

• Stock sits for 60 days before it sells.
• Customers take 45 days to pay after you invoice them.
• You pay your own suppliers after 30 days.

Cycle = 60 + 45 - 30 = 75 days. For 75 days, every sale is money you have spent but not yet recovered. Grow that business by 50 percent and the gap grows with it, which is exactly why fast growth can drain a profitable company.

Not every business has this problem

Here is the encouraging flip side. Some business models collect cash before they pay for it, which gives them a negative cash conversion cycle. These businesses are funded by their own operations as they grow, which is one of the most powerful positions in finance.

• A subscription business that bills annually in advance holds the customer’s cash for months before it delivers most of the service.
• A marketplace that takes payment at the point of sale and pays suppliers weekly holds float in between.
• A business that takes deposits before starting work funds the work with the customer’s money, not its own.

If you can design your model, or even one product line, to collect earlier and pay later, you turn working capital from a headwind into a tailwind. It is worth asking, deliberately, whether your terms can move in that direction.

Why growth makes it worse

For most trading and product businesses, though, the cycle is positive, and this is the cruel part: the faster a business with a positive cash cycle grows, the more cash it swallows. Each new order needs stock bought and staff paid now, while payment arrives 75 days later. Growth is not free. It is funded, and if you are not funding it deliberately with a plan, you are funding it accidentally with your survival buffer.

Put numbers on it. A business doing 5,000,000 a month with a 75-day cycle has roughly 12,500,000 tied up in working capital at any time. Double its sales and, all else equal, the cash it needs locked up roughly doubles too, to about 25,000,000. That extra 12,500,000 has to come from somewhere: profit retained, a facility arranged, or an investor. A growth plan that forgets this is a plan that stalls in month four with a full order book and an empty account.

Investors know this. When they look at a growth forecast, one of the first things they check is whether the working capital to support it has been budgeted. Showing that you have modelled it is a strong signal of financial maturity.

Releasing cash you have already earned

The good news is that shortening the cycle releases cash you already own, without raising a single naira. Three levers:

1. Collect faster (reduce receivable days). Invoice the day you deliver, not at month end. Ask for deposits on large orders. Make paying easy, with clear terms and simple payment options. Chase politely but promptly, because a quiet invoice is an unpaid invoice. Shaving 45 days to 30 on a business turning over 60 million a year frees up roughly 2,500,000 in cash, permanently.
2. Hold less stock (reduce inventory days). Every item on a shelf is cash sitting still. Order more often in smaller quantities where your supplier allows it, and clear slow-moving lines even at a discount to turn them back into cash. Dead stock is the most expensive thing in many businesses precisely because it looks like an asset while behaving like a hole.
3. Pay on terms, not early (extend payable days). Negotiate longer terms with suppliers and use the full period. Paying a 30-day invoice on day 30 rather than day 5 keeps that cash working in your business for three more weeks. This is not about paying late and damaging relationships; it is about not paying early out of habit.

Move all three even modestly and a business can free up a month or two of runway from its own balance sheet. That is often faster, cheaper and less dilutive than raising.

Warning signs to watch

• Your sales are up but your bank balance is flat or falling.
• A growing share of your revenue sits in “money owed to us” rather than in the account.
• You are paying suppliers faster than customers pay you, and the gap is widening.
• You reach for an overdraft to cover payroll in the same months you report a profit.

Any of these means cash is leaking into the working capital gap faster than it returns.

What to do this week

• Calculate your three numbers: average days stock sits, average days customers take to pay, average days you take to pay suppliers.
• Add them into your cash conversion cycle. Write the number down. It is one of the most important figures you are probably not tracking.
• Pick the single largest of the three and attack it. Usually it is receivables, and usually the fix is simply invoicing sooner and following up.
• Before your next growth push, estimate the extra working capital it will need, and decide where that cash comes from before you commit.

Profit tells you the business model works. Working capital tells you whether you will survive long enough to enjoy it. Watch both.