Vinu: Manu, I often see borrowers showing good profits but still defaulting on loan repayments. How does that happen?

Manu: Because profit is an accounting concept, while loan repayment depends purely on cash flow. A business can be profitable on paper and still be cash-starved.

Vinu: Can you explain that with a simple example?

Manu: Sure. Suppose a company shows a profit of ₹60 lakh. But debtors increase by ₹1 crore and inventory rises by ₹40 lakh. Operating cash flow becomes negative despite profits.

Vinu: So the issue starts in operations itself?

Manu: Most of the time, yes. Slow collection from customers and excess inventory block cash. Profit does not pay EMIs—cash in the bank does.

Vinu: What role do credit sales play here?

Manu: A major role. If sales of ₹5 crore are largely on credit and collections are delayed by 120 days, the company may look profitable but struggle to pay even ₹5 lakh as monthly EMI.

Vinu: How does capital expenditure affect this?

Manu:  When profits are reinvested into fixed assets without proper funding. For example, using working capital to buy machinery worth ₹80 lakh creates immediate cash stress.

Vinu: Many promoters say, “Profit is there, cash will come.” Is that valid?

Manu: That is a dangerous assumption. Cash comes only when customers pay. Until then, the bank faces repayment risk regardless of reported profit.

Vinu: How should bankers identify this risk early?

Manu: By comparing net profit with operating cash flow. If profit is ₹50 lakh but operating cash flow is negative for two consecutive years, it’s a warning signal.

Vinu: What about term loan repayments?

Manu: Term loans are serviced from cash accruals. If cash from operations is insufficient, the borrower may depend on fresh loans or rollovers, leading to eventual default.

Vinu: So what is the key lesson for bankers?

Manu: Always lend based on cash flow, not profit. Profits indicate performance; cash flow determines repayment capacity.

Vinu: Understood. A profitable business can fail a loan, but a cash-positive business rarely does.

Manu: Exactly. For bankers, cash is reality—profit is only theory.

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