Cash flow

What it means

Cash flow is the real movement of money - what came into the account and what left it. It differs from profit in the profit and loss statement because profit arises when the invoice is issued, while the money arrives only after the due date.

It splits into three streams: operating (ordinary trading), investing (buying and selling assets) and financing (loans, owner contributions, dividends). A healthy company runs a positive operating stream - the other two only fund it.

Cash flow is not the same as liquidity. Liquidity is a snapshot: whether the company can pay what falls due today. Cash flow is movement over a period. A company can have plenty in the bank and still run a negative operating stream that will drain it within months. Depreciation, by contrast, lowers profit but has nothing to do with cash, which left when the asset was bought.

How it works in practice

Cash flow is what most profitable companies trip over. Money is tied up in working capital: stock on the shelf, invoices on 60-day terms, VAT paid on an invoice the customer has not settled.

A simple weekly outlook is usually enough: bank balance, expected receipts, payables falling due, wages, contributions and VAT. That table spots trouble three weeks before the annual accounts do.

For seasonal businesses such as construction or tourism we build a monthly forecast for the whole year with the client. It shows in which months an overdraft or a postponed investment will be needed, and when applying for a loan the bank gets a document that makes sense instead of a figure guessed at the last minute.

What to watch out for

Watch the two outflows that are not costs and therefore never appear in a profit plan: repayment of loan principal and a profit distribution. Both drain the account in full.

The second trap follows a good year. The income tax balance and higher tax advances are paid only in the following year, by which time the profit may long since have gone into stock or equipment. Anyone who left them out of the plan ends up paying tax from the overdraft or asking for instalments.