Chapter 03 · Building a simple financial model
Cash, working capital, and debt
Profit does not pay the bills. Cash does. This chapter takes the workshop’s profit and asks how much of it is trapped in unpaid invoices and in the store room, and what a loan does to the remainder.
Debtor days are a use of cash
The workshop’s revenue is ₹2 crore and its customers pay, on average, 60 days after the sale. Roughly, the cash tied up in receivables is 60/365 of ₹2 crore, about ₹33 lakh. If next year revenue rises to ₹2.20 crore and customers still take 60 days, receivables rise to about ₹36 lakh. The extra ₹3 lakh is profit you have earned and not collected. It is a use of cash. If, at the same time, customers start taking 90 days, receivables become about ₹54 lakh. You have ‘grown’ and you have also lent your customers an extra ₹20 lakh. A model that grows revenue and leaves debtor days untouched will show cash that the company will not have.
Stock and suppliers
The same arithmetic applies to inventory, using cost rather than revenue, and in the opposite direction to payables. If suppliers give you 30 days, they are financing part of the stock. Lengthening debtor days and shortening payable days at the same time is a squeeze, and it often happens together in a downturn, which is when it is least affordable. Put both in the input block. Then compute the change in working capital as a line in the cash flow, not as a vibe.
A year in which profit rises and cash falls
| Rupees, sketch | |
|---|---|
| Operating profit | 30 lakh |
| Depreciation included inside the fixed cost, added back because it is not cash | 8 lakh |
| Increase in receivables | −20 lakh |
| Increase in inventory | −10 lakh |
| Capital spending on a machine | −25 lakh |
| Cash left before interest and debt | −17 lakh |
The company made a profit and spent more cash than it generated. Nothing is broken in the accounting. A machine was bought, and customers owe more. The model has done its job by showing you the ₹17 lakh gap. The next question is where the ₹17 lakh comes from: a cash pile that already exists, or new debt. If you plug the gap with debt, interest next year rises, which flows back into profit. That loop — debt up, interest up, cash tighter, debt up — is the loop you built the model to see before a lender sees it for real.
Debt is an input with a temper
Write the opening debt, the interest rate, and the repayment schedule as inputs. Do not let debt be a silent plug that grows without a limit. A silent plug will fund any fantasy of capital spending and will never ask whether a bank would actually lend it. Put a ceiling in a note beside the debt line: this company could plausibly borrow this much on this profit, and not more. If the model wants more, the capital spending or the debtor days have to give. Those are the real arguments. ‘We will raise debt’ is not an argument until the ceiling is stated.
What to remember
- A rise in debtor days or in stock is a use of cash. Growth makes it larger.
- Depreciation is not cash. Capital spending is cash, and it often exceeds depreciation.
- Profit up and cash down is a normal output. Read it instead of smoothing it away.
- If debt funds the gap, interest feeds back into next year’s profit. Let the loop run.
- Give debt a ceiling you can defend. An unlimited plug will fund any story.