Profit is an accounting measure built on estimates, accruals and timing choices. Cash is a fact recorded by a bank. When the two tell different stories for more than a year or two, due diligence has to find out why. A business that reports growing profits but repeatedly draws on its overdraft or raises funds to pay suppliers is not converting its earnings into value for shareholders.
This article focuses on the cash side of financial due diligence: how the EBITDA-to-cash bridge is built, what cash conversion levels mean, how a proof of cash test works using bank statements and GST returns, and which presentation choices can make operating cash flow look stronger than it is. It is aimed at investors, lenders and finance teams preparing for scrutiny.
Key points at a glance
- Cash conversion (operating cash flow ÷ EBITDA) is one of the first metrics reviewed; a persistent gap needs a clear explanation.
- The EBITDA-to-cash bridge separates working capital, tax, capex and one-off items so each can be tested.
- A proof of cash reconciles revenue and expenses in the books with bank receipts and payments.
- Reconciling books, GST returns and bank credits is an efficient check on revenue in Indian transactions.
- Bill discounting, delayed supplier payments and capex classification can move cash flow between periods or categories.
Why profit and cash differ
Differences between profit and cash are normal. They arise from:
- Working capital: sales on credit, stock built ahead of demand, and supplier credit taken or repaid.
- Non-cash items: depreciation, provisions, unrealised foreign exchange gains or losses and fair value changes.
- Timing of tax: advance tax and TDS paid versus tax expense recognised.
- Capital expenditure: cash spent on assets that is expensed over many years.
The due diligence question is not whether a difference exists, but whether it is explained by the business model and whether it is stable, reversing or widening.
What is the cash conversion ratio?
Cash conversion is usually measured as operating cash flow before tax divided by EBITDA, and sometimes as free cash flow (operating cash flow less maintenance capex) divided by EBITDA. There is no universal benchmark: a subscription software business may convert above 100% because customers pay in advance, while a project contractor may be well below 100% in growth years. What matters is consistency with the business model and with peers, and the trend over time.
Building the EBITDA-to-cash bridge: a worked example
Consider a distribution company reporting EBITDA of ₹12 crore, where the balance in the cash credit account has increased during the year. The due diligence prepares the following bridge:
| Item | ₹ crore | Comment |
|---|---|---|
| Reported EBITDA | 12.0 | As per audited accounts |
| Increase in trade receivables | (5.5) | Debtor days up from 60 to 85 |
| Increase in inventory | (2.5) | Stock built for a new product line |
| Increase in trade payables | 2.0 | Supplier payments delayed at year-end |
| Non-cash income in EBITDA | (0.8) | Provision reversal credited to income |
| Operating cash flow before tax | 5.2 | Cash conversion 43% |
| Income tax paid | (2.4) | |
| Maintenance capex | (1.3) | Vehicle and warehouse replacement |
| Free cash flow | 1.5 | 12.5% of EBITDA |
The bridge shows that only ₹1.5 crore of the ₹12 crore EBITDA was available to service debt or pay dividends. Two further points follow. First, the ₹2 crore increase in payables flatters the cash flow; if suppliers insist on normal terms after the deal, that cash goes out. Second, the ₹5.5 crore increase in receivables needs to be analysed by customer: is it growth, a change in terms or collection trouble? Without those answers, the reported EBITDA overstates the cash-generating capacity of the business.
Proof of cash: testing the books against the bank
A proof of cash reconciles receipts and payments recorded in the books with bank statements for a period, usually month by month. In summary:
- Obtain statements for all bank accounts, including those not in the trial balance but in the company's name.
- Reconcile opening balance, receipts, payments and closing balance for each account to the books.
- Match customer receipts to invoices and trace large receipts to the named customer.
- Identify receipts not linked to revenue, such as loans, capital, inter-company transfers and refunds.
- Review round-trip transactions: amounts received from a customer and paid out shortly after to a related party or supplier.
Practical point: A three-way reconciliation of revenue in books, outward supplies reported in GSTR-1 and GSTR-3B, and bank receipts from customers is an efficient test in Indian deals. Differences can have valid reasons (exports, advances, credit notes, timing), but each needs to be explained and, where GST is short-paid, quantified as an exposure.
Presentation choices that can inflate operating cash flow
Bill discounting and factoring
Discounting receivables with recourse converts them into cash early, but the company still carries the credit risk. Where proceeds are shown as a reduction of receivables rather than borrowing, operating cash flow looks stronger. Due diligence adds such facilities back to debt and to receivables for analysis.
Stretching payables at the period-end
Holding back supplier payments in the last weeks of the year raises operating cash flow. Comparing month-end payables across the year and checking payments in the first weeks of the next year usually reveals this. Delayed payments to MSME suppliers beyond the period under the MSMED Act, 2006 also raise tax cost under Section 43B(h) of the Income-tax Act, 1961 (Section 37 of the Income-tax Act, 2025), apart from interest liability under that Act.
Classification between operating and investing
Costs capitalised as assets appear as investing outflows rather than operating outflows. If recurring costs such as software development or major repairs are capitalised, operating cash flow and EBITDA both look higher, while free cash flow is unchanged.
Customer advances
Large advances received near year-end improve cash but create a delivery obligation. The review checks whether advances are normal for the business and whether they are repayable.
Warning signs in the cash profile
- Cash conversion falling for two or more years while EBITDA rises.
- Regular drawings on working capital facilities to fund routine expenses.
- Equity or promoter loans needed to meet operating payments.
- Large differences between GST turnover and books without documentation.
- Cash balances concentrated at year-end and falling immediately afterwards.
Frequently Asked Questions on Cash Flow vs Profit in Due Diligence
Why can a profitable company have negative cash flow?
Because profit includes credit sales, inventory build-up and non-cash items, while cash flow reflects actual collections and payments. Rapid growth, slow collections or heavy capex can make cash flow negative even when profit is positive.
What is a good cash conversion ratio?
It depends on the business model; what matters is that the ratio is consistent over time, comparable with peers and explained by working capital and capex patterns.
What is a proof of cash in due diligence?
It is a reconciliation of receipts and payments in the books with bank statements for each account and period, used to confirm that recorded revenue and expenses are supported by actual cash movements.
How does bill discounting affect cash flow analysis?
Discounting receivables with recourse brings cash in early but leaves the credit risk with the company. Due diligence usually treats outstanding discounted bills as debt and adds them back to receivables.
Why reconcile GST returns in financial due diligence?
GST returns are an independent record of reported supplies. Differences with books or bank receipts can point to revenue misstatement or to GST exposure that should be quantified.
What is free cash flow in due diligence?
Free cash flow is operating cash flow after tax less capital expenditure, often limited to maintenance capex, and shows the cash available to lenders and shareholders.
Conclusion
An EBITDA-to-cash bridge and a proof of cash turn a general concern about cash into specific, testable items. They show how much of the reported profit is available after working capital, tax and capex, and whether that result depends on year-end timing.
Businesses with durable profits usually show stable cash conversion, receivables and payables that move in line with activity, and books that reconcile with bank and GST records. Where these links break, the explanation found in due diligence often matters more to the investor than the reported profit figure.
This article is intended for general information and knowledge sharing only and does not constitute professional advice or solicitation of any kind. Provisions are summarised as of September 2026. Readers should refer to the relevant provisions, regulations and judicial pronouncements for their specific facts.