Profitable on Paper, Short on Cash: Why Working Capital Can Make or Break a Business

EDITOR’S NOTE: Profit and cash are not the same thing. A company can report strong earnings, carry substantial assets on its balance sheet, and still struggle to make payroll or pay vendors on time. Cash may be low because it’s tied up in inventory, sitting in accounts receivable, or simply going out the door faster than it comes back in.

Every business needs to manage its cash, and to do that, it needs to understand some basic aspects of working capital.

Working Capital Starts with a Simple Equation

Put simply, working capital is what remains after subtracting short-term obligations from the assets the business owns or expects to convert to cash relatively soon.

• Current assets typically include cash, accounts receivable, inventory, and other resources expected to be converted into cash within about a year.
• Current liabilities generally include accounts payable, accrued expenses, short-term debt, and other obligations due within roughly the same period.

Working capital is easy to calculate, but that does not mean that adequate working capital is easy to maintain. The real question is whether the business can actually get the cash it needs when it needs to pay the bills. John Levitske of GlassRatner Advisory & Capital Group LLC sums it up: “Working capital is a calculation.” A company can look strong on paper but still run into trouble if it cannot turn assets into cash quickly enough.

The same warning applies to EBITDA, which should not be confused with cash flow. EBITDA looks at a company’s earnings without deducting interest expenses, taxes, depreciation, or amortization. It is a useful measure of operating performance, but it was never designed to show how much cash a company actually has on hand. That is because EBITDA leaves out several items that directly affect the bank account, including changes in working capital, capital spending, debt service, and actual cash taxes. So, a company can report strong operating earnings while its bank balance tells a much less comfortable story.

Where Cash Gets Stuck

Inventory and accounts receivable are two of the most common places where cash gets tied up. Inventory has value on the balance sheet, but the business has already spent money to buy or produce it. Until the goods sell, that cash is locked away, unavailable for payroll, vendors, or new investment.

Jonathan Wernick of GlassRatner Advisory & Capital Group LLC uses a useful shorthand for the inventory side of the equation: “turn you earn.” The point is practical: Inventory has to move before the money committed to it can return to the business.

Accounts receivable are assets, but they are not usable cash until they are collected. A sale may be recorded today while payment arrives 30, 60, or 90 days later. During that gap, the invoice may improve the balance sheet without helping the company pay today’s bills. The gap between recording revenue and collecting cash is where working capital problems begin, and it is rarely as short as anyone expects.

Cash Conversion Is a Timing Problem

Taking a step back, the term operating cycle is the time it takes for a business to turn what it buys, such as raw materials or inventory, into cash (i.e., revenue collected from sales). When that process drags out, the company’s cash becomes tied up in the business instead of being free to pay employees and suppliers, service loans, or invest in growth.

Payment terms can stretch or compress that cycle. An e-commerce transaction may generate cash almost immediately. A customer buying on extended terms can leave the seller waiting weeks or months. Vendor terms push in the opposite direction, determining how quickly cash must be paid.

Wernick describes cash conversion as “a dance.” The business is constantly balancing how much inventory to carry, how quickly to collect receivables, when to pay vendors, and how much cash to keep available for the next obligation.

That is why working capital management cannot be reduced to a single target number. Shorter customer terms may speed up collections. Longer vendor terms may preserve cash on hand. But pushing either lever too hard can damage the relationships the business depends on.

Even Good Numbers Can Be Misleading

A healthy working-capital number can hide real problems. Receivables may be growing because customers are paying more slowly, not because sales are booming. Inventory may be climbing because products are not moving, not because the company is stocking up for a big quarter. In both cases, the balance sheet says the assets are there. But the cash is not.

The opposite can also be true. Negative working capital is not always a distress signal. Some businesses collect cash from customers before they have to pay their own suppliers. Restaurants are a familiar example: customer payments arrive immediately, inventory turns over in days, and vendor invoices may not come due for weeks. For businesses like these, negative working capital is the model, not a flaw in it.

The number on the balance sheet is a starting point, not the whole answer. What matters is whether the company can actually convert its assets into cash quickly enough to meet its obligations as they come due.

Cash Flow Is an Operating Discipline

Working capital is part of running the business, not simply an accounting exercise. Sales teams influence credit terms. Purchasing teams determine how much inventory the company carries. Collections staff affect how quickly receivables are converted to cash. Those day-to-day choices determine how much room the company has to make payroll, fund growth, and handle ordinary expenses.

Ken Yager of Newpoint Advisors captured the point neatly: “You can’t make payroll on receivables.” A receivable may ultimately be collectible, and inventory may eventually sell, but neither replaces cash that is available when an obligation is due.

This is where a “cash flow culture” matters. The people making everyday decisions need to understand how those decisions affect the company’s liquidity. In a tight period, a 13-week cash-flow forecast and active stakeholder management can help leadership spot shortfalls early, accelerate incoming cash where possible, and conserve available funds rather than treating EBITDA as a stand-in for liquidity.

Look Ahead Before Cash Gets Tight

A 13-week cash forecast is a practical way to spot problems before they hit. The point is not to know the exact numbers, but to see cash crunches coming while there is still time to react.

When building a cash forecast, do not just look at the numbers. Test the real-life problems that disrupt cash flow all the time:

• What if customers drag their feet paying you?
• What if shipments show up late?
• What if you have to slash prices to clear old stock?
• What if a big bill lands earlier than you thought?

Businesses can also watch Days Sales Outstanding, inventory turnover, and Days Payables Outstanding. Those measures show how quickly receivables are collected, how quickly inventory moves, and how long the company takes to pay vendors. Together, they help explain where cash is tied up and how quickly it is moving through the business.

Working Capital Becomes a Legal Issue in M&A

When a business is sold, working capital becomes part of the purchase-price negotiation. Buyers generally expect the company to enter closing with sufficient operating working capital to continue operating without an immediate cash infusion. That expectation is often expressed through a working-capital target, commonly called a “peg.”

In middle-market transactions, the parties commonly compare the target against estimated and actual working capital at closing. The resulting post-closing working-capital true-up can increase or decrease the final purchase price.

The purchase agreement needs to spell out exactly what goes into the calculation: which assets and liabilities are included, which accounting rules or historical practices govern, how the peg is set, and how any post-closing disagreement will be resolved.

A working-capital adjustment is also different from an earnout. The adjustment addresses the condition of the business at closing. An earnout, by contrast, ties additional consideration to future performance after closing.

Deals may also use representations and warranties, indemnification provisions, escrows, holdbacks, and R&W insurance to allocate post-closing risk. These tools address who bears the cost if agreed facts about the business prove inaccurate or if specified liabilities surface after closing.

Talk It Out: It Can Save You Money

Improving working capital does not always require a new loan or an outside investment. Sometimes, the first step is better communication with the people already expecting payment.

As Wernick points out, “Communication with all the stakeholders is really important.” A vendor may be more flexible if it receives a clear payment date. A customer may pay sooner if collection efforts begin before the account becomes seriously overdue. Internally, sales and purchasing teams can make better decisions when they use the same cash forecast.

That communication becomes even more important when financial pressure increases. In a distressed business, working capital and operating debt are central parts of the company’s liquidity picture, and poor timing can quickly narrow management’s options.

Profit Is Only Half the Story

Working capital answers the question that an income statement cannot: When does the business actually get the cash?

• A business needs inventory to generate revenue, but excess inventory locks up cash.
• Competitive credit terms can support sales, but slow receivables weaken liquidity.
• Paying vendors quickly can preserve goodwill, but paying them earlier than necessary can create a shortfall somewhere else.

There is no universal working-capital target that fits every business. The right level depends on the industry, operating cycle, capital structure, seasonality, and risk profile of the company.

So, when the income statement shows strong profits, but the bank balance is low, the money has not necessarily disappeared. It may simply be tied up in inventory, waiting in aging receivables, or leaving the company sooner than management planned.

To learn more about this topic, view “Where Did All My Profits Go? Mastering the Concept of Working Capital.” The quoted remarks referenced in this article were made either during this webinar or shortly thereafter during post-webinar interviews with the panelists. Readers may also be interested in reading other articles about business management.

This article was originally published on September 7, 2026.

©2026. DailyDAC™ LLC d/b/a/ Financial Poise™. This article is subject to the disclaimers found here.