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The Case of the Disappearing Profits
By Paul Beretz, CICE, Pacific Business Solutions

aniel Dapper, a dynamic salesman with limited financial expertise, founded LIV-HI INC., a CA corp. in 1997. While his profit margins were thin, the business grew to $100,000 monthly sales by the by the latter part of 2001. In December of that year, Mr. Dapper began an expansion program designed to produce an increase of 50% in sales with all expectations of getting his business to a very profitable level.

The program he had outlined gave immediate results. Sales increased dramatically from $100,000 in December to $150,000 by January 2002. As indicated in the very simple summary income statement below (also known as "operating statement" or "profit and loss statement"), the higher revenue generated $15,000 in earnings the first month:

LIV-HI Inc., Income Statement, 1/1/02- 1/31/02



Cost of Sales


Gen. $ Admin exp.


Net Income


However, Dan Dapper (known as "Dandy" to his friends) was not in a position to enjoy his success. While the company showed profits, the big jump in sales lead to a $25,000 cash flow deficit. By the end of January 2002, the company was out of cash.


  1. The cash flow deficit was not the result of any unusual event - it developed from the relationships that would impact Dan's cash flow.
  2. The deficit was a surprise to the owner (and maybe creditors?). He thought that a profitable operation meant positive cash flow.

What is more important - profits or cash flow? What Mr. Dapper forgot was that the income statement is an accrual statement - it records sales when they occur, not 30 days later, when the business collects the accounts receivable. In addition, expenses are accrued as incurred, although a company may pay those obligations later. Some expenses, such as depreciation and amortization of prepaid items, represent prior cash payments and this even adds more mystery (smoke) to the picture of cash flow - to creditors and the owner.

What Dan Dapper should have recognized in his cash flow is that:

  1. A/R, the only source of cash for LIV-HI Inc., may turn (or may not turn) in an average of 30 days.
  2. Dan bought $105,000 in inventory in December to meet January's sales forecast and to maintain its credit rating, they had to pay in 30 days.
  3. Dan pays all operating expense as incurred, with non-accrued for payment in the following month.

So with these facts in mind, Dan's projected and actual cash flow for January would be:

LIV-HI Inc., Cash Flow 1/1/01-1/31/01

Beginning Cash (in bank)
Collections (Dec. sales)
Operating Expenses
Payments (December purchases)
Cash shortage

Conclusion: What appears to be a $15,000 profit for the month of January is a $25,000 cash flow deficit. The $40,000 difference emphasizes the difference between accrual and cash accounting.

Solving the Mystery: Dan Dapper could have filled the funds gap with external financing, additional investment or accelerating collections of accounts receivable.

What is the Moral of the Story? Credit managers beware: look for the "hidden card," the smoke, the mirrors: watch the flow of cash!

1 Paul Beretz, CICE (Certified International Credit Executive), is the founder and Managing Director of Pacific Business Solutions, a consulting company which specializes in providing strategic planning and cash flow solutions. Paul received his BBA from the University of Notre Dame, an MBA from Golden Gate University and the Executive Award from the Graduate School of Credit and Financial Management at Stanford University. His e-mail is

Reprinted by permission from Trade Vendor Quarterly
Blakeley & Blakeley LLP Spring 02

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