How can a business be profitable and still run out of cash?

Because profit and cash are measured on different clocks. Profit counts a sale when you make it. Cash counts it when the money arrives. A business can do everything right on the income statement and still fail to pay its staff in March.

Where the gap comes from

Four things open it up, and a question will usually point at one.

Credit sales. You sell 50,000 of goods in May on 60-day terms. Profit recognises it in May. The cash lands in July. Everything you owe in June has to come from somewhere else.

Inventory. Cash goes out when you buy stock. Profit is not affected until you sell it. A business building up stock for a busy season converts cash into goods on the shelf, and the income statement says nothing at all.

Non-current asset purchases. Buying a 40,000 machine takes 40,000 of cash immediately. Profit is reduced only by that year's depreciation, maybe 8,000. The other 32,000 has left the bank and appears nowhere in profit.

Depreciation itself. It reduces profit but moves no cash at all. This is the one that surprises people in the other direction: a business can show a loss and still have positive cash flow, because the loss includes a charge nobody paid.

Working it through

A business makes 120,000 of credit sales in a year, all at 60-day terms, and pays its suppliers in 30 days. Profit might be healthy. But at any moment it is waiting on two months of sales income while having already settled one month of purchases. That gap, permanently, is working capital the business has to fund.

Grow the business and the gap grows with it. This is why fast-growing firms fail. More sales means more stock bought and more customers owing money, both of which consume cash before any of it comes back. The term for it is overtrading, and it is a profitable company's way of going under.

What the answer should do

If a question asks how a profitable business ran out of cash, do not stop at "profit is not cash". Name the mechanism from the scenario — the credit terms, the stock build-up, the asset bought outright — and trace it.

The structured version that scores: cash left for X, the matching revenue has not yet arrived because Y, so the business must fund the gap from Z. Then a realistic fix: tighter credit control, a shorter collection period, leasing the asset instead of buying it, or an overdraft facility sized to the gap.

Avoid the vague answer that the business needs "better cash flow management". That restates the problem. The marks are for naming which part of the cycle is consuming the cash and what specifically would shorten it.