Balance Sheet vs Cash Flow: Why Profits Don't Always Mean Liquidity

by KarNivesh | 22 September, 2025

When we talk about a company’s financial health, two words often come up—profitability and liquidity. At first glance, they might seem similar. After all, if a company is making profits, shouldn’t it also have plenty of cash? The truth is more complicated. A business can show high profits on paper while still struggling to pay its bills, salaries, or suppliers.

This blog explains why profits don’t always mean cash, by breaking down the differences between the balance sheet and cash flow statement, exploring the profit vs liquidity paradox, and highlighting the real-world reasons why companies face cash flow problems despite being profitable.

Balance Sheet vs Cash Flow Statement - Understanding the Key Differences

Balance Sheet vs Cash Flow – The Basics

Think of a balance sheet as a snapshot of a company’s finances at one moment in time. It lists:

• Assets – what the company owns (like cash, receivables, or inventory).

• Liabilities – what it owes (like loans or bills).

• Equity – the owners’ share of the business.

The golden rule is:Assets = Liabilities + Equity

For example, a company might show cash of ₹50,000, accounts receivable of ₹75,000, and inventory of ₹1,00,000. On the other side, it could have accounts payable of ₹60,000 and short-term loans of ₹75,000.

Now compare that with the cash flow statement. Instead of a snapshot, it’s like a movie, showing how money moves in and out over time. It covers three areas:

1. Operating activities – everyday business cash inflows and outflows.

2. Investing activities – buying or selling assets.

3. Financing activities – loans, equity, or dividend payments.

The key difference? The balance sheet includes both cash and non-cash items, while the cash flow statement shows only actual money movement. That’s why a company can look profitable on its balance sheet and income statement, but still face liquidity troubles in real life.

Why Profitable Companies Face Cash Flow Problems - 6 Key Reasons

Profit vs Liquidity – The Paradox

• Profitability = how much a company earns after expenses.

• Liquidity = how easily a company can pay its short-term obligations using cash or near-cash assets.

A shocking fact: about 38% of startups fail simply because they run out of cash, even when they are profitable on paper. Why? Because profits are calculated under accrual accounting—where sales are recorded when earned, not when cash is received.

Six Reasons Profitable Companies Struggle with Cash Flow

1. Timing MismatchA consulting firm might finish a ₹5,00,000 project in March, but get paid only in June. Profits show in March, but cash comes months later—leaving the company to cover salaries and rent without fresh income.

2. Slow Customer PaymentsBusinesses often give clients 30–90 days to pay. A manufacturing company could have ₹10,00,000 in invoices due but no cash to pay workers or buy raw materials.

3. Heavy Inventory InvestmentA retail shop may spend ₹20,00,000 on stock for the festive season. Until those goods sell, the cash is stuck in inventory, even though future profits look good.

4. Capital InvestmentsA restaurant chain might buy new equipment worth ₹15,00,000. While this boosts long-term profits, the immediate cash outflow squeezes liquidity.

5. Loan RepaymentsA company paying a loan installment of ₹50,000 each month (₹30,000 principal + ₹20,000 interest) sees only the interest reduce profit on paper. But in reality, the full ₹50,000 leaves the bank account.

6. Rapid GrowthIronically, fast-growing companies often face the worst cash crunch. A software startup doubling in size may need new staff and servers long before customer payments catch up.

Accrual vs Cash Accounting – Why It Matters

• Accrual accounting: Records income when earned and expenses when incurred, regardless of cash movement. Example: A ₹50,00,000 construction project is recorded in December, even if payment comes in March.

• Cash basis accounting: Records only when money changes hands.

Accrual gives a better long-term picture but creates short-term liquidity challenges.

Accrual vs Cash Accounting - Understanding the Liquidity Impact

Working Capital – Balancing Act Between Profit and Cash

Working Capital = Current Assets – Current Liabilities

Example:

• Current assets: Cash ₹3,00,000, receivables ₹8,00,000, inventory ₹12,00,000

• Current liabilities: Payables ₹4,50,000, short-term loans ₹2,00,000, wages payable ₹1,50,000

If assets exceed liabilities, working capital is positive, meaning the company can cover short-term needs. But too much idle cash can reduce returns, while too little makes the business risky.

Working Capital Management - Balancing Liquidity and Profitability

Common Cash Flow Problems

• Late payments from customers: Firms may have crores in invoices but no liquidity. Solutions include early payment discounts or invoice factoring.

• Seasonal fluctuations: Retailers earn most profits in festive seasons but struggle during off-peak months.

• Overstocking: Ties up lakhs or crores in unsold goods.

• Rapid growth: Requires upfront investment before cash inflows catch up.

• High fixed costs: Rent, salaries, and insurance drain cash even in slow months.

Practical Solutions

1. Cash Flow Forecasting – Predict inflows/outflows weekly or monthly.

2. Faster Collections – Offer online payment, discounts for early payments, or milestone billing.

3. Smart Payables Management – Negotiate better payment terms with suppliers.

4. Access to Financing – Maintain credit lines or use invoice factoring.

5. Build Reserves – Keep cash worth at least 3–6 months of expenses.

Industry Examples

• Tech startups: Spend lakhs or crores on development before seeing returns. Need strong investor backing.

• Manufacturing: Cash locked in raw materials for months. Needs efficient supplier terms.

• Services: Consulting firms face delayed payments despite high profits.

• Retail: Seasonal cash crunch due to bulk inventory purchases.

Ratios That Matter

• Current Ratio = Current Assets ÷ Current Liabilities (Healthy: 2:1).

• Quick Ratio = (Current Assets – Inventory) ÷ Current Liabilities.

• Cash Ratio = Cash ÷ Current Liabilities.

For profitability:

• Net Profit Margin = Net Income ÷ Revenue.

• Return on Assets (ROA) = Net Income ÷ Assets.

• Return on Equity (ROE) = Net Income ÷ Shareholders’ Equity.

Warning Signs of Cash Trouble

• Profits rising but cash declining.

• Customers taking longer to pay.

• Inventory piling up.

• Struggling to pay suppliers on time.

• Missing payroll deadlines.

Final Takeaway

Profits are important, but cash is king. A business may look successful on paper yet collapse due to poor cash flow management. The smartest companies not only aim for profitability but also focus on cash flow forecasting, working capital efficiency, and maintaining liquidity.

Mastering the balance between profitability and liquidity ensures survival in the short term and growth in the long term. That’s why investors, lenders, and managers pay as much attention to cash flow statements as they do to income statements.