The cash flow statement, explained

Here is the fact that catches out more businesses than any other: profit is not cash. A company can be profitable on paper and still run out of money, because the profit-and-loss records revenue when it’s earned, not when it’s collected. The cash flow statement is the third core statement that closes this gap — and it’s the one that tells you whether a business can actually pay its way.

Why profit and cash differ

Under accrual accounting, you book a sale when you invoice it — but the cash may arrive 60 days later, or not at all. Meanwhile you’ve paid staff and suppliers. So a booming, profitable month can be a cash crisis if receivables pile up faster than they’re collected. The cash flow statement makes that visible.

The three sections

• Operating activities — cash from the actual running of the business: collections from customers, payments to suppliers and staff. This is the most important section; healthy businesses generate cash here.
• Investing activities — cash spent on or received from long-term assets: buying equipment, selling property.
• Financing activities — cash from owners and lenders: loans taken or repaid, capital invested, distributions paid out.

Add the three and you get the net change in cash for the period — which should reconcile exactly to the movement in the bank balance on the balance sheet.

What it reveals

A business with strong profit but weak operating cash flow is a warning: it’s earning but not collecting, or tying cash up in inventory. A business funding itself mostly through financing (borrowing) rather than operations is living on borrowed time. The cash flow statement is where these truths, hidden on the P&L, come out.