Rising profits comfort investors, but cash decides survival

Summary: Earnings growth often masks financial stress. By looking at cash conversion rather than profits, investors could have seen Ruchi Soya’s troubled years in advance. This piece explains the metric that separates real profits from optical ones.

One of the most dangerous assumptions investors make is equating profits with financial strength. A company that reports steady earnings is often assumed to be safe. History shows otherwise. Companies rarely collapse because they report losses. They collapse because profits fail to convert into cash.

This is why cash conversion—how much of a company’s operating profit actually shows up as operating cash flow—matters more than margins, growth or even reported earnings.

Profits are an opinion. Cash is a fact.

Profits are shaped by accounting choices: revenue recognition, inventory valuation, capitalisation policies and depreciation. Cash flows are far less flexible. Either cash comes in, or it does not.

A business with strong cash conversion generates operating cash flows broadly in line with its EBITDA. Such companies can fund growth internally, service debt comfortably and absorb shocks. Weak cash conversion, on the other hand, means profits exist largely on paper. Growth becomes dependent on borrowing, and financial risk builds quietly.

When growth looks healthy, but cash keeps leaking

The most dangerous phase for investors is not when profits fall, but when profits rise and cash does not. Revenues grow, EBITDA expands and the business looks healthy. Yet operating cash flows fail to keep pace.

Suggested read: How to read the cash flow statement: A beginner's guide

This gap rarely looks alarming in a single year. It compounds slowly. Each year, more capital is required to support the same operations. Debt rises not to create productive assets, but simply to keep the business running. By the time stress becomes visible, the damage is usually done.

Ruchi Soya: how profits hid a broken cash engine

The collapse of Ruchi Soya is a textbook example of how weak cash conversion can destroy shareholder value despite reported profitability.

For several years, Ruchi Soya appeared to be a solid, large-scale edible oil business. Revenues were substantial, operating profits were reported consistently, and the company enjoyed a strong presence across the edible oil value chain. To many investors, it looked like a stable beneficiary of India’s consumption growth.

The cash flow statement told a very different story.

Despite reporting EBITDA, operating cash flows consistently lagged. Profits were not turning into surplus cash. Instead, most of the operating surplus was getting absorbed within the business itself. To bridge this gap, the company relied increasingly on short-term borrowings.

Debt was not funding expansion, technology upgrades or durable assets. It was funding the conversion of profits into working capital. That is a critical distinction investors often miss.

Ruchi Soya’s collapse is often attributed to disruptions in global palm oil markets after policy actions by Indonesia, the world’s largest palm oil exporter. Export restrictions, levies and domestic price controls led to sharp volatility in prices and availability.

These events certainly hurt the business. Inventory costs rose, margins came under pressure and liquidity tightened. But it is important to understand this clearly: Indonesia did not cause the collapse.

The real problem was that Ruchi Soya had no cash buffer. Years of weak cash conversion had already stretched the balance sheet. Once lenders became cautious and funding dried up, the company had no internally generated cash strength to fall back on. Profits could not protect it. Insolvency followed.

What looked like a sudden collapse was, in reality, the inevitable outcome of structurally poor cash conversion.

Using the CFO to EBITDA to spot such risks early

One of the cleanest ways to assess cash conversion is to compare operating cash flow (CFO) with EBITDA over a longer period.

EBITDA reflects operating profitability before financing and accounting effects. CFO reflects the actual cash generated from operations. When analysed on a five-year cumulative basis, this comparison filters out annual volatility and exposes underlying business economics.

Below is a snapshot of companies comparing the five-year cumulative CFO with the five-year cumulative EBITDA.

What stands out is how low cash conversion is for many companies, despite healthy market capitalisations and reported profitability. In some cases, cumulative CFO is a small fraction of cumulative EBITDA. In others, it is negative.

This does not automatically mean these companies are poor investments. But it does mean investors must ask a critical question: are profits strengthening the balance sheet, or merely inflating it?

Why does this metric not work everywhere

CFO to EBITDA is powerful—but not universal.

In BFSI, operating cash flows behave very differently because cash itself is the raw material. Movements in deposits and loans distort CFO, making the metric meaningless.

In gold-linked businesses, inventory accounting and periodic revaluation can make cash flows appear weak or volatile despite stable economics.

In real estate and infrastructure, cash flows are inherently lumpy due to long project cycles. Even a five-year window may understate true cash generation.

This is why the CFO-to-EBITDA ratio should be used as a diagnostic lens, not a blunt screening tool. It works best in manufacturing, consumer, industrial, chemical and engineering businesses—precisely where operating profits should eventually show up as cash.

Why block-period analysis matters

Cash flows are noisy year to year. Inventory build-ups, project execution and timing issues can distort annual numbers. That is why analysing cash conversion one year at a time often misleads investors.

Over a five-year period, however, a genuinely strong business will convert most of its EBITDA into operating cash. If it does not, the problem is not timing. It is structural.

Ruchi Soya failed this test well before its collapse.

The real investing lesson

Cash conversion determines whether growth strengthens a business or quietly weakens it. Profits attract attention, but cash determines survival.

For long-term investors, the most important question is not whether a company is profitable, but whether those profits actually show up as cash over time.

Because when cash conversion breaks down, the P&L stops mattering—and by then, it is usually too late.

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