Why a profitable business can run out of cash
A company can report a profit every year and still be unable to pay its bills. The usual cause is growth: selling more means lending more to customers and holding more stock before the cash arrives. This lesson shows the mechanism on a small fictional distributor, finds the growth rate it cannot afford, and then looks at how Apple and Microsoft avoid the problem.
- Level
- Beginner
- Reading time
- About 19 minutes
- Know this first
- Sensitivity and scenario analysis
By the end you will be able to:
- trace how receivables, stock and payables turn a profit into a cash shortfall
- work out the growth rate at which a business uses all of its operating cash
- list the levers a business has to close a working capital gap
- compare the working capital cycles of two large companies
Profitable, and still out of cash
A company fails when it cannot pay what it owes on the day it falls due. It does not fail because its income statement shows a loss. Plenty of businesses that report a profit in every year of their short lives run out of money, and the commonest cause is not fraud or bad luck. It is growth. Selling more means buying more stock, and waiting longer in total for customers to pay, and both happen before the profit on the extra sales arrives as cash. Accountants call the result overtrading: doing more business than the cash behind it can carry.
The lesson on working capital and the cash cycle introduced the three clocks that decide how much money sits in receivables, stock and payables. This lesson asks a different question: how fast can a business with a given margin and a given cycle grow before it uses up all of its operating cash? There is an answer, a growth rate, and it can be worked out before the cash runs out rather than after.
The mechanism, in a small business
Take a fictional wholesale distributor, invented for this lesson and not based on any real company. Last year it sold $100 million of goods and the goods cost it 70% of the price. It earns an 8% profit on sales. Customers take 60 days to pay, its stock sits for 75 days before it is sold, and it pays its own suppliers after 40 days. (Stock and payables are counted in days of the cost of goods, as in the working capital lesson.) It began the year with $1.0 million in the bank.
Those habits tie up money. Receivables are $16.4 million, stock is $14.4 million and payables are $7.7 million, so the business needs $23.2 million of working capital to support $100 million of sales, which is 23.2% of sales. That figure matters more than any other in this lesson. Every extra dollar of sales this business makes needs about 23.2 cents of working capital to carry it, whatever the profit.
Now suppose sales grow 60% to $160.0 million. Profit at 8% is $12.8 million. But the three balances have grown with sales, so receivables rise by $9.9 million, stock by $8.6 million and payables by only $4.6 million, a net build of $13.9 million. Cash from operations is the profit less that build: $12.8 million less $13.9 million, which is a shortfall of $1.1 million. The income statement says the best year the business has had, and the bank balance goes down.
The growth speed limit
Write it as a formula. If the balances keep the same number of days, working capital grows in step with sales, so the cash tied up in a year of growth g is g times last year's working capital. Profit is the margin times the new sales. Cash from operations is zero when the two are equal:
This business can grow by up to 52.8% a year and still cover the working capital from its own profit. Past that, it has to find the difference from somewhere else: a bank, the owners, or a customer or supplier willing to change the terms. The table shows what happens at five growth rates, holding everything else at the starting settings.
| Sales growth | Profit | Working capital build | Cash from operations |
|---|---|---|---|
| 0% | 8.0 | 0.0 | 8.0 |
| 20% | 9.6 | 4.6 | 5.0 |
| 40% | 11.2 | 9.3 | 1.9 |
| 60% | 12.8 | 13.9 | −1.1 |
| 80% | 14.4 | 18.5 | −4.1 |
At no growth the business keeps all of its $8.0 million of profit as cash. Each step up in growth raises profit, and raises the working capital build faster, so the cash left falls and then turns negative somewhere between 40% and 60% growth, consistent with the 52.8% calculated above. The faster the business grows past that point, the larger the hole.
There is a second result in the formula. If the margin is larger than the working capital as a share of sales, the subtraction in the denominator goes negative and there is no speed limit at all: cash from operations stays positive however fast sales grow. A business with a 25% margin and 23% working capital, say, never uses up its operating cash by growing. A business with an 8% margin and 23% working capital always will if it grows fast enough. The rule of thumb is to compare the margin with the working capital intensity.
Run the distributor
Change the growth, the margin and the three clocks. The left page shows where the year's profit goes: how much is lent to customers, how much is put into stock, how much is borrowed back from suppliers, and what cash from operations is left. The right page adds the opening cash, shows the closing balance, and gives the growth the business could sustain from its own profit and, if cash from operations is negative, how many months the opening cash would last at that rate. The business is fictional, and the model leaves out tax, depreciation and capital spending to show one pressure on its own.
Profit is $12.8 million, but $13.9 million more is tied up in receivables and stock net of payables, so cash from operations is −$1.1 million and the business has 11.0 months of cash left at that rate.
Six experiments. First, at the starting settings the business has made $12.8 million and spent $13.9 million on working capital, leaving a shortfall of $1.1 million that the opening cash covers for 11.0 months. Second, cut growth to 20% and cash from operations becomes $5.0 million positive. Third, go the other way to 80% and the shortfall is $4.1 million, enough to use up the opening cash in 2.9 months. Fourth, return to 60% growth and cut the days customers take to pay from 60 to 30: cash from operations is $3.8 million positive. Fifth, stay at 60% and stretch supplier terms from 40 to 70 days: $2.4 million positive. Sixth, raise the margin from 8% to 12%: $5.3 million positive. Any one of the three levers is enough to turn this business around, and each has a price, which the next section looks at.
The ways out, and what each one costs
A business that sees the gap coming has four main choices, and each lands on someone.
Slow down. Lower growth cuts the build directly. It costs the business the sales it passes up, which is why it is the last choice for most owners.
Shorten the clocks. Collecting faster, holding less stock or selling faster all release cash. Customers may leave if the terms tighten, and a smaller stock risks running out of what customers want.
Stretch payables. Paying suppliers later is borrowing from them without a loan agreement. They may charge more, ask for payment in advance, or stop supplying, and a supplier that is also short of cash can be hurt by the delay.
Raise money. A bank loan, a new share issue or invoice financing, in which a lender advances cash against unpaid invoices, can cover the gap. They cost interest or ownership, and a lender will want to see the same arithmetic as this lesson, which is why a loan against a growing business can be hard to get at the moment it is most needed.
The match between the funding and the need matters too. Working capital that grows with sales is a lasting need, and covering it with a loan due in a few months invites a second crisis when the loan has to be renewed.
Two large companies and the same test
Apple and Microsoft apply the same test and pass it easily, for different reasons. The working capital lesson compared their cycles in days. Here the question is the one the formula asks: how much working capital does each dollar of sales tie up, and is the margin big enough to pay for it? The table uses fiscal 2025 year-end balances, receivables plus stock less payables, as a share of sales.
| Measure, fiscal 2025 | Apple | Microsoft |
|---|---|---|
| Receivables plus stock less payables, $ billion | −24.4 | 43.1 |
| As a share of sales | −5.9% | 15.3% |
| After deducting deferred or unearned revenue | −8.0% | −8.6% |
| Operating margin | 32.0% | 45.6% |
| Working capital movement in the year, $ billion | −25.0 | −5.4 |
| Cash from operations, % of net income | 99.5% | 133.7% |
Apple's receivables and stock are smaller than its payables, so the measure is negative: 5.9% of sales. More sales give it cash, because suppliers fund more than customers and stock together take up. Microsoft's measure is positive at 15.3% of sales, but its operating margin is 45.6%, about three times as large, so growth pays for itself on this test even before anything else is counted. Microsoft also collects cash before it delivers: its unearned revenue was $67.3 billion, 23.9% of sales, and counting that against receivables turns its measure negative as well, at 8.6% below zero. Apple, counting its deferred revenue the same way, goes to 8.0% below zero.
This does not mean working capital is free for either company. In fiscal 2025 changes in operating assets and liabilities used $25.0 billion of Apple's cash and $5.4 billion of Microsoft's, and Apple's cash from operations came to 100% of its net income against 134% at Microsoft. This lesson does not try to explain what drove each movement. The point is the comparison with the fictional distributor. Their margins are 32.0% and 45.6%, against 8%. They also hold less working capital than the distributor's 23.2% of sales, or negative amounts once advance payments are counted. Together those two facts remove the growth speed limit for both.
Neither company is a model for a small distributor, and the comparison is not advice to imitate it. Margin and terms of this kind come from a brand, a platform or a contract that most businesses lack. What the comparison shows is where the pressure comes from: not from growth as such, but from growth in a business whose margin is thin and whose working capital is heavy. Two large companies can look quite different in their cycles and still both pass.
What this model leaves out
- Tax, interest and capital spending. The model treats profit as cash before working capital. A real business also pays tax and often has to buy equipment to grow, which makes the limit lower.
- Constant days. It assumes the clocks do not change with growth. In practice rapid growth often slows collections or builds excess stock, which makes the problem worse.
- A single year. The model looks at one year of growth. A business that keeps growing at the same rate repeats the build every year, so the cumulative gap is larger.
- Year-end balances. Seasonal businesses can be far shorter of cash at the peak than at year end.
- Margin on new sales. It assumes the new sales earn the same margin. Discounts used to win new customers may cut it.
Common mistakes
Judging a growing business by its profit
Profit says the sales were worth making. Cash from operations says whether they can be afforded. A lender or a founder needs both.
Assuming growth is always good news for cash
It is, for a business with a negative cycle and a big margin. For a thin-margin business with heavy working capital it can be the cause of the shortage.
Funding a permanent need with short-term money
Working capital that grows with sales stays. Short-term borrowing has to be repaid or renewed, and a lender can refuse.
Counting receivables as cash
A receivable is a promise. A customer who pays late, or not at all, turns a reported sale into a hole.
Relying on suppliers without asking them
Stretching payables works while suppliers allow it. A supplier that cuts terms in the middle of a growth spurt can push the business over its limit.
Try it yourself
1. A company has sales of $365 million a year and customers take 60 days to pay. How much is owed to it at any time, and how much more does it need if sales grow by 20% and the days stay the same?
Show the working
Sales per day are $1 million, so 60 days of sales is $60 million owed. After growth of 20% the balance is 20% larger, so $12 million more is tied up in receivables.
2. Customers take 45 days, stock sits for 60 days and suppliers are paid after 30 days. What is the cash conversion cycle?
Show the working
45 + 60 − 30 = 75 days: the business funds its operations for 75 days between paying suppliers and collecting from customers.
3. A business earns a 6% margin and needs working capital equal to 25% of sales. What growth rate can its own profit fund?
Show the working
Growth = margin ÷ (working capital share − margin) = 6 ÷ (25 − 6) = 31.6%. Faster than that and it needs outside money.
4. A founder proposes to fix a cash shortage by paying suppliers later. Name one benefit and one risk.
Show the working
The benefit is that cash stays in the business for longer, which cuts the working capital needed. The risk is that suppliers may raise prices, demand payment in advance or stop supplying, so the saving can cost more than it is worth.
Where this is used
- A lender tests whether a borrower's plan for growth can be paid for by its own cash before it agrees to a loan.
- A founder works out how much cash a large new order will need before the customer's payment arrives.
- A finance team sets a limit on growth or on customer credit that the business can carry.
- An analyst reads a company's rapid sales growth together with its cash from operations to see whether the growth is paying for itself.
Key terms
- Overtrading
- Growing sales faster than the business can finance, so that it runs short of cash while profitable.
- Working capital intensity
- Working capital as a share of sales: the cash tied up for each dollar of sales.
- Cash conversion cycle
- Days of receivables plus days of stock less days of payables.
- Self-funded growth
- The growth rate a business can sustain from its own profit without outside money.
- Invoice financing
- Borrowing against unpaid customer invoices.
- Runway
- How long the cash lasts at the current rate of spending.
Questions people ask
Is this a problem only for small companies?
Small and fast-growing companies meet it most often, because they have thin cushions. A large company with a heavy cycle and thin margins can meet it too. The two companies in this lesson show the reverse: size is not the protection, margin and terms are.
Does a bigger profit solve it?
Only if the margin rises, since a bigger profit from bigger sales brings a bigger working capital build with it. The formula shows the point: higher margin raises the speed limit, while higher sales alone does not.
How is this different from the lesson on cash and profit?
That lesson explained why profit and cash differ. This one asks how far apart they can drift in a growing business, and gives a way to calculate the rate at which the gap starts to bite.
Can a business with a negative cash cycle run out of cash?
Not by growing, but a slowdown reverses the effect, as the working capital lesson showed. It can still run out for other reasons, such as heavy capital spending or debt due.
Sources and review
- Apple Inc., Form 8-K, Exhibit 99.1: fourth quarter and full-year fiscal 2025 results, filed with the US Securities and Exchange Commission. Source of Apple's statements.
- Microsoft Corporation, Form 8-K, Exhibit 99.1: fourth quarter and fiscal year 2025 results, filed with the US Securities and Exchange Commission. Source of Microsoft's statements.
How the numbers were checked: Apple's and Microsoft's balances and margins were rebuilt from their filed statements and tied to the totals. Every figure for the fictional distributor was recomputed in plain code, the growth speed limit was confirmed by running the model at that growth rate and finding cash from operations of zero, and the calculator, which runs separately, was compared with that code across a grid of inputs.