Everything you need to know about cash flow

Key takeaways

• A company can be profitable yet lack the cash flow to pay its short-term expenses; it is this situation that most often leads to insolvency.
• Cash flow consists of three types of cash flows: operating (day-to-day operations), financing (loans, repayments), and investing (purchases of securities, dividends).
• The basic formula is simple: cash flow = cash received – cash paid out. A positive result means that the company generated cash during the period.
• There are three main ways to improve cash flow: speeding up customer payments, controlling expenses, and optimizing inventory management
• Establishing a rolling 12-month cash flow forecast allows you to anticipate future cash flow constraints and make the right decisions before the situation worsens.

Cash flow is the difference between a company’s cash inflows and outflows. Calculating a company’s cash flow therefore provides a clear picture of current and future cash flows, and thus of the funds available at a given point in time, as well as in the coming weeks or months. As a result, cash flow is an essential concept for both the owner of a small business and the CFO of a mid-sized company. Indeed, it serves as an indicator of the company’s financial health, for it is important to remember that a company can be profitable and thus generate profits, yet still lack sufficient cash on hand to cover its short-term expenses. Yet it is this type of cash flow strain that most often leads companies to default on payments, not a lack of profitability. That is why we invite you to explore in detail the concept of cash flow, its calculation, its analysis, and the tools at your disposal to improve your cash flow.

Cash flow refers to the flow of cash within a company, that is, incoming cash flows (such as payments received from customers) and outgoing cash flows (such as payments made to suppliers and for expenses), both current and future. 
The concept of cash flow is therefore closely linked to that of movement, since it is not limited to analyzing the current balance in the company’s bank account as with cash on hand but goes further. It incorporates changes in liquidity by taking into account contractual payment terms and collection periods, where applicable.

Consequently, cash flow must be clearly distinguished from accounting profit. Cash flow refers to the cash available at a given date, even in the future. We therefore record expected inflows by that date such as customer payments, as well as outflows, such as VAT payments, supplier invoices, and so on.
In contrast, accounting profit is what the company has earned at the end of its fiscal year. However, it is entirely possible to generate profits and thus operate a profitable business, while still facing significant cash flow pressures. The company may then experience significant difficulties in paying its short-term expenses. This can even lead to the deferral of payments

Here is a concrete example to illustrate the difference between cash flow and profit.
A service company bills €10,000 for the month of March. On paper, the business is profitable because, after deducting salaries, expenses, rent, and equipment costs, there is a net profit of €4,000.

 

The problem is that customers pay within 60 days. In practical terms, in March, the company doesn’t receive any of the €10,000 it has invoiced. On the other hand, it must immediately pay its ongoing expenses, such as salaries, payroll taxes, rent, and subscriptions—amounting to approximately €6,000 that leaves its bank account before it has even been paid by its customers.

 

The company therefore has a book profit of €4,000, but a negative cash flow of €6,000, which will reduce its bank account balance. If the company does not have sufficient funds to cover its expenses while waiting for payments from its customers, it risks running into financial difficulties.

There are generally three types of cash flows: 

 

In addition to these three categories of cash flow, we can also mention the concept of free cash flow. Free cash flow corresponds to the cash available after all operating and financing expenses have been covered. It represents the net cash flow available. This indicator is also very important because it helps determine the feasibility of an investment or whether or not dividends can be paid to shareholders.

The simplest formula for calculating a company’s cash flow over a given period is: 

 

 

Example:
In March, a company received €8,000 in customer payments and paid €5,500 in operating expenses (salaries, payroll taxes, rent, subscriptions, suppliers)

 

The cash flow is calculated as follows: €8,000 – €5,500 = +€2,500

 

Here, the cash flow is positive. The company generates €2,500 in cash over the month. This will increase its bank account balance by that same amount.

Two methods can be used to calculate cash flow. The main difference lies in the reference period and the items included in cash inflows and outflows.

 

On the one hand, the direct method of calculating cash flow aims to take into account only the expected inflows and outflows in the short term over the given period. In practice, we look at the expected inflows resulting from customer invoices issued in the previous month(s), and we list the expected outflows such as loan repayments, supplier invoices to be paid, salaries, etc. To do this, we rely primarily on the bank statement for the period under review and on invoices issued that are pending payment.

On the other hand, the indirect method of calculating cash flow allows for a more in-depth analysis of the company’s financial health. Indeed, this method takes into account the net income for the entire fiscal year. Here, the goal is not only to determine the amount of available cash, but also to identify ways to improve the company’s cash flow. In practice, one can examine collection KPIs to see if the delinquency rate and average payment terms (DSO) are too long, for example, or analyze supplier payment terms to negotiate more favorable ones.

The cash flow statement is a very useful tool for analyzing a company’s financial health. It makes it easy to identify, over a given period, where the cash generated by the company comes from and where it goes.

 

Unlike the income statement, the cash flow statement does not focus on revenues and expenses. It is based solely on cash flows.

 

Generally, a cash flow statement consists of three sections, each corresponding to a type of cash flow: 

 

Here is an example of a simplified cash flow statement:

Cash flow	Amount
Cash flows from operating activities
Customer payments	+ 12 000 €
Payments to suppliers and expenses	– 9 000 €
Operating cash flow	+ 3 000 €
Investment flows
Purchase of hardware/software	– 1 500 €
Funding flows
Loan repayment	– 800 €
Change in cash and cash equivalents during the period	+ 700 €

In this example, the company’s operations generate €3,000 in cash flow. Part of this money is used for investments, and another portion is used to repay loans. Ultimately, the company’s cash balance increases by €700 over the period.
It is important to note that operating cash flow should never be viewed in isolation. It is directly influenced by the structure of the Working Capital Requirement (WCR). Indeed, a decline in operating cash flow can be explained by

In the cash flow statement, these changes result in an increase in working capital, which consumes cash, even though the net income remains positive. Conversely, shorter customer payment terms or better inventory management automatically lead to a more favorable operating cash flow.

 

The challenge, therefore, is not merely to track changes in cash flow, but to identify which operational factor (customers, suppliers, inventory) is driving these changes so that concrete action can be taken.

To improve your company’s cash flow, you have three key strategies at your disposal. The first strategy to implement is accelerating collections. In practical terms, this means shortening the payment terms you contractually grant to your customers. At the very least, you can adjust the payment terms based on the customer’s profile, including their length of business relationship, order volume, payment history, and whether they have a history of late or unpaid payments, etc. The goal is to bring cash into the business as quickly as possible to increase available liquidity.

The second lever to pull in order to optimize cash flow is controlling outflows, that is, expenses. It is essential to regularly analyze the expenses paid by the company. You can then renegotiate your contracts, pricing terms, etc., and possibly switch suppliers if you can secure better terms while maintaining the same level of quality

 

And the third major lever is aimed at optimizing inventory. Effective inventory management enables companies to respond quickly to customer demand without tying up too much capital. This is especially true since inventory also incurs storage costs.

 

Whether or not you’ve already taken advantage of these three strategies, there’s a very effective way to improve your cash flow: negotiating payment terms with your service providers and suppliers. If you can secure longer payment terms for your expenses, this gives you time to receive payments from your customers so you can cover those costs without any issues. Ideally, whenever possible, your collection terms should be shorter than your payment terms.

On the other hand, certain tools allow for more precise management of cash flow, namely:

 

Anticipating cash flow is just as important as calculating it. A positive cash flow at a given moment does not guarantee that the company will be able to meet its future obligations. Cash flow pressures are most often linked to timing differences in cash receipts, recurring expenses, or decisions made without sufficient visibility. Cash flow forecasting allows you to proactively manage these issues rather than simply reacting to them.

In practical terms, this involves forecasting cash inflows and outflows on a month-by-month basis (customer payments, salaries, expenses, supplier payments, taxes, loan repayments, etc.) based on an initial cash balance. The goal is not to be perfectly accurate, but to have a realistic view of how the bank balance will evolve in order to anticipate periods of financial strain and aid in decision-making.

Cash flow forecasting proves even more useful when it incorporates multiple scenarios. Assessing the impact of late payments, a decline in business, or a delay in an investment allows you to adjust decisions in advance and maintain cash flow.

 

It is also possible to take the analysis a step further by adopting a more structured forecasting approach, particularly through rolling 12-month cash flow forecasts. This method allows you to maintain a constantly updated medium-term view and anticipate cash flow constraints earlier. Furthermore, leveraging management tools such as ERP systems or treasury management solutions (TMS) facilitates the centralization of cash flows, the automation of forecasts, and access to up-to-date dashboards and reports. These tools improve visibility into cash flow trends and enhance the ability to manage cash flow more proactively.

How can you maintain a positive cash flow over the long term?

Maintaining a positive cash flow over the long term depends above all on simple, consistent practices such as invoicing promptly, tracking payments, controlling expenses, and managing financial commitments prudently. These measures are effective only if they are applied consistently over time, rather than on an ad hoc basis.

 

Cash flow must therefore be monitored regularly. An occasional check is not enough to anticipate future cash flow problems, whereas frequent monitoring even if it is simple, helps to quickly detect any deviations and take action before the situation worsens

 

Furthermore, cash flow management is not solely the responsibility of the finance department. Sales teams directly influence payment terms, while operations teams impact invoicing, costs, and inventory management. Sustainable cash flow relies on a shared vision and aligned practices across the entire organization.

 

Top-performing companies structure this management process through clear procedures, such as the Order-to-Cash process, monitoring of key performance indicators, industry benchmarks, and the development of a strong cash management culture. Backed by shared KPIs, cash flow management then becomes a strategic lever that drives the company’s overall performance.

Cash flow is a key indicator that is easy to understand and essential for managing a company’s finances. It is essential to monitor it to ensure the company’s financial health. After exploring what this concept entails how to calculate, improve, and anticipate your company’s cash flow it becomes clear that managing cash flow provides a genuine competitive advantage, regardless of the company’s size.