Cash flow, and why buyers trust it more than profit

Every owner has lived some version of this moment. The accounts say you made a profit. The bank account says you cannot pay Friday's wages without chasing three invoices.

That gap between profit and cash is not an accounting quirk. It is one of the most important things a buyer looks at when they price your business. Owners rarely hear this explained, because most valuation conversations stop at profit and a multiple.

This guide explains why buyers care so much about cash, what the profit figure hides, and what you can do about it before you sell. If you have read our guide on how buyers value a business, this is the natural next chapter.

Profit is the result of accounting judgements. When to recognise revenue. How fast to depreciate a van. Whether that old debtor is really going to pay. Reasonable accountants can look at the same business and produce different profit figures, all of them defensible.

Cash is not like that. Money either arrived in the account or it did not. Wages either went out or they did not.

A buyer can argue with your profit figure. Nobody can argue with your bank statements.

This is why experienced buyers spend as much time on the cash flow statement and the bank position as they do on the profit and loss. It is the part of the accounts that cannot be dressed up.

In the valuation guide we explained that buyers usually start from adjusted EBITDA. That is true, and it remains a useful starting point, because it lets a buyer compare businesses with different debt, tax positions and accounting policies.

But starting point is the key phrase. Charlie Munger, Warren Buffett's business partner for over fifty years, famously dismissed EBITDA as nonsense earnings. His point was simple. EBITDA pretends that some very real costs do not exist.

Three in particular:

• Capital spending. Vans wear out. Machines break. Computers age. Depreciation is the accountant's estimate of that cost, and EBITDA removes it. But the replacement van still has to be paid for with real money
• Working capital. Stock on the shelf and invoices waiting to be paid are cash you have spent but not yet recovered. EBITDA ignores both
• Tax. The business pays it. EBITDA does not

A business can show £300,000 of EBITDA and generate £80,000 of actual spendable cash once vans are replaced, stock is bought and tax is paid. Another business with the same EBITDA might generate £250,000. They are not worth the same, whatever the multiple says.

The money left after all of that is called free cash flow. It is the money an owner could actually take out without harming the business. It is what a buyer is really buying.

Here is the version of this that catches good businesses. Growth eats cash.

Say you win a large new contract. You buy stock and materials up front. You pay staff weekly or monthly. Your new customer pays you on 60 day terms, and pays late on top. Every month of growth means more money going out today against money arriving in three months.

A worked example. A business grows sales by £40,000 a month:

The profit and loss shows a profitable new contract. The bank account shows £31,000 gone. The customer's money arrives eventually, but until the position settles, the business is funding its own growth out of its own pocket. Plenty of profitable businesses have failed exactly this way.

Buyers know this pattern well. When we see strong profit growth alongside a deteriorating bank position, we do not assume something dishonest. We assume working capital, and we look closely at how it is being funded.

When we look at a business, these are the cash questions we ask:

• Debtor days. How long customers actually take to pay, not the terms on the invoice
• The profit to cash gap. Over the last three years, how much of the reported profit turned into money in the bank
• Capex history. What has been spent keeping equipment and vehicles up to date, and what spending has been deferred. A tired fleet is a cost the buyer inherits
• Seasonal swings. The bank balance in the worst month of the year, not the best
• Customer terms. One large customer on 90 day terms can strain a business more than a dozen small ones paying in 30

None of this is a trick. It is simply the difference between what a business earns on paper and what it produces in money.

Take two businesses, each with £250,000 of adjusted EBITDA.

The first converts most of its profit into cash. Customers pay in 30 days, equipment is up to date, the bank balance grows steadily. The second converts perhaps a third. Slow payers, a stock pile that never shrinks, two years of deferred spending on vehicles.

On paper they look identical. To a buyer they are not close. The first business will attract a stronger multiple, a cleaner offer and less deferred consideration. The second will still sell, but the buyer will price in the cash they must inject after completion, and the offer will show it.

This is one of the main reasons two owners with the same profit can receive very different offers, and why the multiple ranges in our valuation guide are ranges. Cash conversion is one of the quiet forces that decides where in the range you land.

The good news is that cash flow responds to attention faster than almost anything else in a business.

• Chase your debtors. Getting average payment from 60 days to 40 is worth real money and shows a buyer the book is collectable
• Deal with dead stock. Sell it, write it down or clear it out. A buyer will discount it anyway, and a clean stock figure is more credible
• Keep essential kit up to date. Deferring replacement spending flatters this year's cash and costs you more in the offer
• Know your own numbers. If you can talk plainly about your debtor days and your worst month, you signal a well run business before the buyer opens a spreadsheet

Start a year or two before you sell and the improvement shows up in the figures a buyer weighs most heavily.

Profit tells a buyer what your business earns. Cash tells them what it produces. A business that turns profit into money in the bank, year after year, is easier to value, easier to fund and easier to buy.

If your accounts show good profits but the bank account never seems to reflect it, that gap has an explanation, and it is worth understanding before a buyer explains it to you.

This guide is general information, not financial, legal or tax advice. Every business and every sale is different. Take advice from your accountant and solicitor before acting on anything here. Exit Ready UK Ltd, company number 17310523, registered in England and Wales.