The 12-Week MBA Chapter 7: Cash Flow and Working Capital Part 2 - Managing the Cash Gap

Your company is profitable on paper but bleeding cash in real life. How does that happen? And more importantly, how do you fix it?

This is post 9 in my 12-Week MBA retelling series.

In Part 1, we looked at why profit and cash flow are not the same thing. Now we dig into the numbers and see exactly how a growing, profitable company can run out of money. Then we talk about working capital and what you can actually do about the cash gap.

When Profit Says Yes But Cash Says No

Let me walk you through an example from the book that really drives this home.

Imagine a company with $10,000 in quarterly sales. After subtracting all costs (making the product, admin, research, depreciation), it earns $800 in net profit. That is an 8 percent margin. Not bad at all.

But here is the problem. The company lets customers pay in 90 days (net 90 terms), while it has to pay its own suppliers in 30 days (net 30 terms). So the company already spent money on materials and labor, but the cash from customers will not show up for another two months.

When you adjust for all that, the operating cash flow comes out to negative $8,000. Yes, you read that right. The company made $800 in profit but lost $8,000 in cash.

If that company started the quarter with $10,000 in the bank, it would be down to $2,000. One more quarter like this and the lights go out.

Growth Makes It Worse, Not Better

Here is the part that messes with your head. You might think, “Okay, but if the company grows, the problem will fix itself.” The opposite is true.

Say sales jump 50 percent in the next quarter, from $10,000 to $15,000. Profit climbs to $2,800. Things look great on the income statement. But cash flow is still negative $1,000. Why?

Because growth means even more customers who have not paid yet. In Q2, the company collects $10,000 from Q1 customers but defers $15,000 from new Q2 customers. The gap between what comes in and what goes out keeps getting bigger as long as the company keeps growing.

This is what the authors call “choking on growth.” The faster you grow, the worse the cash problem gets. Your business could be winning on profitability and growth, and the cash flow dynamics could still kill it.

Real Companies That Almost Died This Way

The book gives two powerful examples.

Lucent Technologies was a telecom equipment giant in the late 1990s. They sold cables and switches to companies building out internet infrastructure. Business was booming. They offered generous payment terms to attract customers. Some of those customers were big reliable companies like AT&T. But others were startups trying to build brand new business models.

When the economy hit a wall in 2001, many of those startups went under. And they took their unpaid bills with them. Lucent’s stock went from over $100 per share to less than $1. More than $100 billion in value just evaporated. The lesson? When you let customers pay later, you are not just trusting your customers. You are trusting your customers’ customers. It is a chain reaction waiting to happen.

Netflix almost died too, but for a different reason. Back when Netflix was a DVD-by-mail company, they offered a three-month free trial to attract subscribers. That is basically 90-day payment terms. Meanwhile, they had to buy three DVDs upfront for every new customer. The cash going out for new subscribers was way more than the cash coming in from people who signed up three months ago.

Netflix was growing like crazy and almost choked on its own success. They survived by cutting the free trial to one month and negotiating better deals with their DVD suppliers. Instead of paying full price upfront for discs, they paid less and shared a cut of their revenue. That closed the cash gap just enough to keep the company alive. The rest, as they say, is history.

What Is Working Capital?

So there is a name for this cash gap problem. It is called working capital.

The simple formula is:

Working Capital = Current Assets - Current Liabilities

Current assets are things like cash, inventory, and accounts receivable (money customers owe you). Current liabilities are things like accounts payable (money you owe suppliers).

There is also a more focused version called trade working capital:

Trade Working Capital = Accounts Receivable + Inventory - Accounts Payable

This strips out cash itself and looks purely at the gap created by your day-to-day business operations. In the book’s example, after Q1 the trade working capital was $11,000. That is $11,000 that the company needs to find somewhere, money from investors or lenders, just to keep the business running.

The authors call it OPM on Wall Street. Other people’s money. That is what fills the gap.

Three Ways to Manage Working Capital

The good news is you can actually do something about this. The book outlines three main approaches.

1. Negotiate Better Payment Terms

If your customers pay you in 90 days but you pay suppliers in 30 days, you have a 60-day gap where cash is just sitting in limbo. What if you could negotiate net 90 terms with your suppliers too?

In the book’s example, matching supplier terms to customer terms would cut trade working capital from $11,000 down to $5,000. That is a huge difference, and you did not have to sell a single extra sandwich or build a better product. You just negotiated better contracts.

This is one of those things that has nothing to do with how great your product is. It is pure business operations.

2. Reduce Inventory

Every dollar sitting in your warehouse is a dollar not in your bank account. Over the past few decades, a lot of business innovation has been about keeping inventory as low as possible. “Just-in-time” manufacturing means you order materials right when you need them, instead of stockpiling stuff that sits around gathering dust.

Even speeding up production helps. Unfinished products sitting on the factory floor are basically money trapped on the balance sheet.

3. Flip the Script with Negative Working Capital

Here is where it gets really interesting. What if, instead of closing the gap, you could flip it completely?

Some companies, like Amazon, have negative trade working capital. Customers pay on delivery. Suppliers get paid 60, 90, or even 120 days later. Cash flows into the company faster than it flows out. It is like building a dam across a river. Cash pools up inside the company, and you can use that pool for anything: growing the business, funding research, saving for a rainy day, or paying dividends to shareholders.

Dell built a multi-billion-dollar company this way. Michael Dell took phone orders with credit card payments upfront, then assembled computers from parts bought on long payment terms. He basically built an empire using his customers’ and suppliers’ money.

For a growing company, negative working capital creates a beautiful cycle. Positive cash flow funds new investments, which generate more cash flow, which funds more investments. It is a rocket that fuels itself.

The Catch: Nothing Is Free

Before you go trying to squeeze every supplier and rush every customer, the authors warn you about the trade-offs.

Cut inventory to zero? Great, until a big order comes in and you cannot fill it. That customer goes to your competitor.

Force customers to pay immediately? Your competitor offers net 30 and steals your business.

Stretch supplier payments to 120 days? Your supplier might raise prices, put your orders at the bottom of the pile, or go bankrupt from their own cash crunch.

The book connects this to a real-world lesson about the global supply chain. Remember the chip shortage during COVID? Car manufacturers had been running lean on inventory for years. No extra chips sitting around. Then Taiwan chip factories shut down temporarily during the pandemic, and suddenly car production slowed to a crawl. Prices skyrocketed, even for used cars.

The authors make a broader point here. When every company in the entire supply chain manages inventory to the bone, there is zero slack in the system. Even a small disruption can cascade. The efficiency that creates shareholder value over a decade can cause massive disruption when something unexpected happens.

Key Takeaway

Profit is not cash. A company can be profitable and still die because it ran out of money. Working capital, the gap between when you pay and when you get paid, is one of the biggest silent killers in business.

You can manage it by negotiating better terms, keeping inventory lean, or even flipping it to negative working capital like Amazon and Dell did. But every optimization has a trade-off. The leanest supply chains are also the most fragile.

The real skill is finding the right balance for your specific business. Not too tight, not too loose. Just enough slack to survive the unexpected while still keeping cash flowing efficiently.

Book: The 12-Week MBA by Nathan Kracklauer & Bjorn Billhardt | ISBN: 978-0-306-83236-9

Previous: Chapter 7 - Cash Flow and Working Capital Part 1

Next up: Chapter 8 - Cost Structures - Fixed vs variable costs and why it matters.

Part of the 12-Week MBA retelling series