‘We sell a lot, but we don’t see the money, we are always running to pay the payroll.’ — Testimony of a businessman
Cash flow – or cash flow statement – is probably the most revealing financial statement of all, and at the same time, one of the least understood and used when it comes to reviewing the financial health of a company. Unlike the balance sheet or income statement, the cash flow tells you directly how much money enters and leaves the company, and most importantly: how much is available at the end of the period. It is a fact, not an estimate: it is what is in the bank.
By legal rule it must be prepared at least once a year. However, the recommendation is to prepare it monthly, together with the balance sheet and the income statement: the three make up a virtuous trinomial that must be read together if you want a complete vision of the business.
The Confuse Utility Trap with Box
It is surprising how, even in companies with years of operation, this powerful tool is still ignored. The attention is usually focused on net profit or the famous ‘adjusted EBITDA’, without stopping to assess if those profits are actually transformed into cash. A company can show attractive accounting benefits and yet be on the verge of illiquidity. That is the paradox that only cash flow can solve.
A company may be selling well or displaying profits, but if it does not carefully manage its operating working capital—inventories plus accounts receivable, fewer accounts payable—the box can be compromised. If customers delay in paying, if inventories accumulate without turnover, or if advance payments are made to suppliers without considering the cash cycle, the result will be a liquidity stress.
Why is it so important?
The box, more than the accounting profit, is what guarantees operational continuity. It is the one that pays the payroll, the suppliers, the taxes, and allows to meet the obligations of the day to day. Proper box management is what allows the entrepreneur to breathe easy, focus on growing and innovating, instead of permanently putting out fires that consume energy and wear out.
What information does it provide?
In the cash flow statement, it can be clearly seen if the business generated enough cash and if it has the necessary resources to meet the expenses of next month. It allows to quickly identify if there is a treasury surplus — more cash than usual — or, on the contrary, if there is a shortage of liquidity that would require seeking financing.
This situation is especially critical for micro-enterprises, since many operate practically “up-to-date”, using the money generated to cover immediate needs, which prevents accumulating capital to invest and scale. Careful cash flow management can make the difference between a limited company in its growth and one that manages to accumulate resources to finance its expansion.
There are two main methods to build a cash flow statement: the direct method and the indirect method. In the next two articles of this series we will explore each in detail.
Clarus Tip: An attractive utility on paper does not guarantee peace of mind on the bank. Check your cash flow as often as you check your sales.
At Clarus Consultores we help you read your cash flow for what it really is: the most honest health thermometer of your business. Let’s talk about the liquidity of your company.