Julian Shocron: Chapter 2, From Profit to Cash
Chapter 1 ended with 100 of net income. The owner looks at the bank account and sees far less to spare. Nothing went missing; profit and cash simply follow different rules.
The bridge
| Step | Amount |
|---|---|
| Net income | 100 |
| Add back depreciation and amortization | +20 |
| Increase in working capital | (25) |
| New ovens bought this year | (60) |
| Free cash flow | 35 |
The add-back reverses a charge that never left the till. The next two lines are cash that did leave, even though neither shows up as an expense on the income statement.
Where the 25 went
Working capital is the money parked inside the operation: what customers still owe plus flour and boxes on the shelves, minus what the bakery still owes its suppliers. It started the year at 15 and ended at 40.
The cause was one large café customer that pays slowly. Here is the same story measured in days:
| Measure | Before | After |
|---|---|---|
| Days to collect from customers | 3.7 | 12.8 |
| Days stock sits on the shelf | 9.1 | 9.1 |
| Days the bakery takes to pay suppliers | 6.1 | 6.1 |
| Cash cycle (collect + shelf − pay) | 6.7 | 15.8 |
Sales did not fall. The bakery just waits about nine extra days for its money, and those days have to be funded by someone, usually the owner.
Why it matters
A business can look healthy on the income statement and still feel tight in the bank. Free cash flow of 35 is what could, in principle, go to lenders or owners without shrinking the bakery. It is the figure Chapter 4 leans on to estimate value.
Two levers would widen it: getting the café to pay sooner, or spacing out oven purchases. Both are business choices, not accounting tricks.
Quick check
- 100 + 20 − 25 − 60 = 35
- 40 − 15 = 25
- 3.7 + 9.1 − 6.1 = 6.7 · 12.8 + 9.1 − 6.1 = 15.8
Assumptions used here: a 365-day year and a cost of the bread sold of 600 for the day counts.
Related note: Julian Shocron on free cash flow. Previous: Chapter 1 · Next: Chapter 3, Debt and safety.