{"id":26881,"date":"2025-12-05T13:43:48","date_gmt":"2025-12-05T13:43:48","guid":{"rendered":"https:\/\/www.refrens.com\/grow\/?p=26881"},"modified":"2025-12-05T13:45:34","modified_gmt":"2025-12-05T13:45:34","slug":"why-companies-go-broke","status":"publish","type":"post","link":"https:\/\/www.refrens.com\/grow\/why-companies-go-broke\/","title":{"rendered":"Why Companies Go Broke: The Working Capital Mismatch"},"content":{"rendered":"\n

Profit & Cash.<\/strong>
You may think these are synonymous with each other. That more cash means more profit, and vice versa.
But in reality, these are poles apart! A company with huge profits can be struggling with cash, whereas a company with huge losses might not.<\/p>\n\n\n\n

If this makes you wonder why a profitable company might not have enough cash, then read further; this blog is the answer to that question!<\/p>\n\n\n\n

In a successful business, the operations pay for themselves. For a business to run smoothly, its operations must sustain themselves, which can be impossible if its cash inflows and outflows don\u2019t match in time.<\/p>\n\n\n\n

In financial terms, it\u2019s when your Debtors Receivable Days are higher than your Creditors Payable Days. <\/strong>This one imbalance drains liquidity from even the most profitable businesses.<\/p>\n\n\n\n

The Lemonade Stand That Ran Out of Cash<\/strong>

Let’s understand this in simpler words. Say, Shreya, aged five, decides to run a lemonade stand as her summer project. She wants to learn business, make money, and buy herself a toy with her profits. So, she gets lemons, sugar, and cups from a vendor, and promises to pay for everything within two hours.

She sets up her cute stand on the street corner. Customers start coming in, love her lemonade, but most of them said, \u201cI don\u2019t have cash right now; I\u2019ll pay you tomorrow when I come again.\u201d

By evening, Shreya has sold 20 glasses of lemonade. Now the fruit vendor is asking for money. But her box is empty because all her customers promised to pay tomorrow.

Here, her receivables (money owed to her) are due tomorrow, but payables (money she owes to others) are due now.
So, she borrows some money from her elder brother, who lends it to her at a set interest rate.

If she doesn\u2019t learn from her mistake, this vicious cycle will never end. Because the margin she earns on her lemonades will continue to be her brother\u2019s interest income, and her dream of buying a toy for herself is gone.<\/p>\n\n\n\n

The example sounds easy, but in real life, we have multiple vendors and multiple customers with different payment terms. So, how should we calculate the Debtor Receivable Days and Creditors Payable Days??<\/p>\n\n\n\n

The calculation can be done using the formulas below \u2013<\/p>\n\n\n\n

Debtors Receivable Ratio<\/strong> = Average Accounts Receivable \/ Credit Sales * 365<\/td><\/tr><\/tbody><\/table><\/figure>\n\n\n\n

Where Average Accounts Receivable = (Opening Accounts Receivable + Closing Accounts Receivable)\/2<\/p>\n\n\n\n

And, <\/p>\n\n\n\n

Creditors Payable Ratio<\/strong> = Average Credit Payable\/Credit Purchase*365<\/td><\/tr><\/tbody><\/table><\/figure>\n\n\n\n

Where, Average Accounts Payable = (Opening Accounts Payable + Closing Accounts Payable)\/2
And, Credit Purchases = Purchases of Stock-in-trade + Change in Inventories of Stock-in-trade<\/p>\n\n\n\n

<\/div>\n\n\n\n

Let us understand with a real-life example, using the Financials of Zomato<\/strong>.<\/p>\n\n\n\n

The Financials of Zomato can be downloaded<\/strong> from the link – https:\/\/b.zmtcdn.com\/investor-relations\/Zomato_Annual_Report_2023-24.pdf<\/a><\/p>\n\n\n\n

<\/div>\n\n\n\n

Debtors Receivable Ratio<\/strong><\/p>\n\n\n\n

Debtors Receivable Ratio<\/strong> = Average Accounts Receivable \/ Credit Sales * 365<\/p>\n\n\n\n

\"Zomato<\/figure><\/div>\n\n\n\n

* For a company as big as Zomato, the entire sales is considered as Credit Sales<\/em><\/p>\n\n\n\n

\"Zomato
Average Accounts Receivable = (Opening Accounts Receivable + Closing Accounts Receivable)\/2
Here,
Opening Accounts Receivable (Trade Receivable) = 457
Closing Accounts Receivable (Trade Receivable) = 794

So, Average Accounts Receivable = 625.5 Cr.<\/figcaption><\/figure><\/div>\n\n\n\n

So, to sum it all up –<\/p>\n\n\n\n

Zomato<\/strong><\/td>Financial Data<\/strong><\/td><\/tr>
Credit Sales*<\/td>INR 12,114 Crores<\/td><\/tr>
Average Accounts Receivable<\/td>INR 625.50 Crores<\/td><\/tr>
Debtors Receivable Ratio<\/td>18.85 Days<\/td><\/tr><\/tbody><\/table><\/figure>\n\n\n\n
<\/div>\n\n\n\n

Creditors Payable Ratio<\/strong><\/p>\n\n\n\n

Creditors Payable Ratio<\/strong> = Average Credit Payable\/Credit Purchase*365<\/p>\n\n\n\n

Where, Average Accounts Payable = (Opening Accounts Payable + Closing Accounts Payable)\/2
And, Credit Purchases = Purchases of Stock-in-trade + Change in Inventories of Stock-in-trade<\/p>\n\n\n\n

\"Expenses
Credit Purchases = Purchases of Stock-in-trade + Change in Inventories of Stock-in-trade
Here,
Purchase of Stock in Trade = 2887
Changes in inventories of Stock in Trade = (5)
So, Credit Purchases = 2887 + (5) = INR 2882 Crores<\/figcaption><\/figure><\/div>\n\n\n\n
\"Liablities
Average Accounts Payable = (Opening Accounts Payable + Closing Accounts Payable)\/2
Here,
Opening Accounts Payable (670 + 9) = 679
Closing Accounts Payable (871 + 15) = 886
So, Average Accounts Receivable = 782.5 Cr.<\/figcaption><\/figure><\/div>\n\n\n\n

So, to sum it all up –<\/p>\n\n\n\n

Zomato<\/strong><\/td>Financial Data<\/strong><\/td><\/tr>
Credit Purchases<\/td>INR 2,882 Crores<\/td><\/tr>
Average Accounts Payable<\/td>INR 782.50 Crores<\/td><\/tr>
Creditors Payable Ratio<\/td>99.10 Days<\/td><\/tr><\/tbody><\/table><\/figure>\n\n\n\n
<\/div>\n\n\n\n

You can see that Zomato receives money from its Debtors in ~19 days;<\/strong> however, it pays its creditors in ~99 days<\/strong>, which helps in good rotation of the money from its Operating Business.<\/p>\n\n\n\n

Zomato gets money from its customers almost 5 times before the payment is due to Creditors<\/strong>! Sounds like a dream for small and mid-size business owners!<\/p>\n\n\n\n

The story is not only about Zomato! This trend will be visible in all the big companies<\/strong>, because they understand the fact that a Business can survive in the long run only if the Working capital churn is proper. The Creditors need to be paid from the money recovered from the Debtors and not through Loans.<\/p>\n\n\n\n

<\/div>\n\n\n\n

The CFO Mindset: From Reactive to Predictive<\/h2>\n\n\n\n

We got to know the problem now! By having higher Receivable days, we are basically financing our own Customers.<\/p>\n\n\n\n

But what about the solution? How can a small and mid-size company make sure that they don\u2019t run into this trap?<\/p>\n\n\n\n

Start small<\/strong> \u2013 Don\u2019t aim at having leverage as Zomato does.

But instead, start with reducing the gap and ultimately making it zero. For instance, if your Receivable period is 45 days and Payable period is 30 days. We need to ensure that this gap is reduced. For ensuring that we can use the below methods \u2013<\/p>\n\n\n\n

1. Identify the customers to focus<\/strong> on through the analysis below \u2013<\/p>\n\n\n\n

1.1 Aging Analysis<\/strong>: Break down receivables by age brackets (0\u201330, 31\u201360, 61\u201390 days) to identify chronic delays. This will help in the identification of major customers where the focus needs to be.<\/p>\n\n\n\n

1.2 Customer-Level Mapping:<\/strong> Identify the top 10 customers with the largest overdue amounts; often, 80% of your receivables come from 20% of clients. <\/p>\n\n\n\n

\u2728For instance, Refrens<\/em><\/strong>‘ AI Assistant Freya<\/em><\/strong> will give you all these answers in seconds, without spending hours on Excel spreadsheets trying to analyze the data points.<\/p>\n\n\n\n

A problem well-stated is half-solved. <\/strong>Once you know the focus area, the work becomes easier as we have a limited set of customers to focus upon!<\/p>\n\n\n\n

2. The next step is to encourage customers to pay faster<\/strong> and nothing motivates quite like money<\/strong>.
Offer a 1\u20132% discount for early payments<\/strong> to make prompt settlement worth their while. Refrens has an inbuilt feature that lets you apply early pay discounts in literally just one click.<\/p>\n\n\n\n

3. Once we have the current situation under control, next steps would be to place good Preventive measures<\/strong> in place in order to avoid running in the same situation again.<\/p>\n\n\n\n

In order to do so, below measures can be adopted \u2013<\/p>\n\n\n\n