Profit is not cash
A business can report net income every month and still run out of money. For a lender, understanding why is the difference between funding growth and funding a collapse.
On Business Training · September 22, 2026 · 5 min read
Net income is an accounting measure: revenue earned in a period, less the costs of earning it. Cash is what’s in the bank. Over a long enough time the two move together, but in any one year they can be far apart. The businesses most likely to show the gap are the ones a factor sees most: growing, selling on terms, and carrying inventory.
Where income and cash part company
A sale counts toward income when it’s invoiced, not when it’s paid. So does the cost of the goods sold. Meanwhile, cash goes out to buy inventory before anything is sold, and comes in only when the customer pays. In between sit three balances:
- Accounts receivable: sales made but not yet collected. Income has been counted; cash hasn’t arrived.
- Inventory: goods paid for, or owed for, but not yet sold. Cash may have gone; no income has been counted.
- Accounts payable: costs incurred but not yet paid. This works the other way, and helps cash.
Together these make up working capital. When working capital grows, it absorbs cash, even though nothing shows up as an expense on the income statement.
A worked example
Ashdown Fasteners Inc. sells to building supply distributors on net 60 terms. To keep the example simple, ignore depreciation, income taxes and distributions. Last year it had net sales of $1,200,000. This year it landed two new customers, and sales rose by half, to $1,800,000. It reported net income of $90,000.
Its working capital at each year end:
| Last year ($) | This year ($) | Change ($) | |
|---|---|---|---|
| Accounts receivable | 200,000 | 300,000 | +100,000 |
| Inventory | 100,000 | 150,000 | +50,000 |
| Accounts payable | 70,000 | 105,000 | −35,000 |
| Working capital | 230,000 | 345,000 | +115,000 |
The business needed $115,000 more working capital to support the higher sales. It earned $90,000. So its cash went down by $25,000 in its best year yet.
Nothing in that is a warning sign on its own. Every growing business that sells on terms faces the same arithmetic. It becomes a problem when growth outruns the funding, which is called overtrading. Look for:
- the bank line fully drawn, and payroll or sales taxes paid late;
- vendors paid later and later, so DPO stretches;
- requests to fund invoices early, or before goods have shipped;
- net income still reported every month, so the owners don’t see why money is tight.
Where factoring fits
This is the gap a factoring facility exists to fill. The facility grows with the receivables. If Ashdown’s facility has an 85% advance rate, the extra $100,000 of receivables could support up to $85,000 of extra availability, as long as those receivables are eligible. That turns a $25,000 cash shortfall into $60,000 of headroom.
That’s the good case. The same arithmetic tells you what to watch:
- DSO. If customers start paying in 90 days rather than 60, receivables grow faster than sales. Invoices that cross your eligibility cutoff stop supporting advances just when the client needs them most.
- Inventory. A receivables facility doesn’t fund inventory. A business whose inventory is growing faster than its sales is building a cash need your facility won’t cover.
- Concentration. Two new customers driving half the growth means two account debtors you need to understand well.
Other ways cash leaves without touching income
Working capital is the biggest gap, but not the only one. Buying equipment or trucks takes cash at once, while income is charged only a year’s depreciation at a time. Paying down a loan, paying distributions and lending money to an officer all take cash and leave net income untouched. The statement of cash flows shows each of these. In interim statements you may have to work them out from the movement in the balance sheet.
Reading it in the financial statements
The financial statements will rarely say any of this outright. If the statement of cash flows is included, start there. If not, put two balance sheets side by side and work out the change in receivables, inventory and payables yourself. Compare the total with the year’s net income. If working capital grew by more than the business earned, ask how the difference was funded: a larger bank line, a new loan, an owner putting money in, or vendors and tax authorities waiting longer.
Questions for the next review
- Is net income turning into cash, or into receivables and inventory?
- How much working capital will next year’s growth need, and who is funding it?
- Is DPO stretching to make up the difference?
- What would happen to cash if the largest customer paid 30 days late?
Net income tells you whether a business is worth funding. Cash tells you whether it will still be there to fund. A lender needs to read both, and to know which one the client is talking about.