A company can sell well, show profits on its income statement, and still struggle to pay its suppliers at the end of the month. To understand how this can happen, it is important to know what cash flow is, also known as cash flow or treasury flow. It is an indicator that measures the actual money coming in and out of a business over a specific period.
The term has been used in the financial world for years, although recently it has lost prominence compared to other indicators like EBITDA. Nevertheless, it remains a basic reference for managers, SMEs, and self-employed individuals who need to know if the business has enough cash to operate, invest, and meet its commitments.
What cash flow measures and what it is used for
The underlying idea is simple. Cash flow captures the difference between the collections and payments of a company over a specific timeframe. If the result is positive, the company has generated more cash than it has consumed. If it is negative, it has spent more money than it has received, which forces it to draw on reserves or external financing.
Its practical utility is twofold. On one hand, it allows measuring the real liquidity of the business, that is, how much available money the company has today to operate. On the other hand, it helps to anticipate tensions. If the finance team sees in advance that in three weeks there will be more payments than collections, it can renegotiate terms, accelerate invoicing, or request a loan before the problem becomes visible.
It also serves as support for decision-making. Hiring staff, opening a new line of business, purchasing machinery, or distributing dividends are moves that should be evaluated based on the cash they leave afterwards, not just the expected impact on the income statement.
The three types of cash flow
To interpret the indicator correctly, it is necessary to distinguish where the money comes from. Cash flow is usually divided into three categories, and each one accounts for a different part of the company's financial life.
The first is operating cash flow, also known as operational cash flow. It reflects the cash generated by the core activity: collections from sales of products or services, payments to suppliers, salaries, and recurring expenses. It is the most important type to know if the business sustains itself. If it is repeatedly very negative, it usually points to structural liquidity problems.
The second is investment cash flow. It captures the inflows and outflows related to assets, such as the purchase of machinery, real estate, or acquisitions of other companies, as well as the sales of those assets. In growing companies, it is common for this flow to be negative for some periods because cash is allocated to expansion or modernization projects.
The third is financing cash flow. It includes movements related to debt and equity: granting loans, paying installments and interest, issuing shares, or distributing dividends. It allows seeing how the company is financed and to what extent it depends on external resources.
How to calculate it
The calculation can be done in several ways depending on the level of detail needed. The most direct method consists of subtracting cash outflows from cash inflows: cash flow equals cash inflows minus cash outflows. It is a useful formula for a general overview of cash flow in a month or a quarter.
In accounting, another widely used version is employed, which starts from net profit. To that figure, depreciation and provisions are added, and changes in working capital are subtracted. The logic of adding the first two items is that neither represents a real cash outflow at that moment. Depreciation reflects the wear and tear of an asset over time and its use, and the provision captures a probable depreciation due to an unforeseen event. Both are recorded as expenses in accounting, but the cash remains in the box.
To illustrate with numbers, let’s imagine an industrial company with these movements in a month: collections from customers of 180,000 euros, payments to suppliers of 110,000 euros, and salaries and operating expenses of 40,000 euros. The operating cash flow would be positive, at 30,000 euros, because the activity generates enough cash to cover its expenses. However, if that same month the company pays a loan installment of 15,000 euros and purchases machinery for 20,000 euros, the net result for the period drops to 5,000 euros in the negative. The activity is functioning, but the final cash flow decreases.
Cash flow and net profit are not the same
One of the most common mistakes is to assume that a business with profits has cash. The income statement is governed by the accrual principle, meaning it recognizes income when the sale occurs, not when it is collected. If a company invoices an order today with a payment in 90 days, the profit appears in the current period, but the money will arrive later. If the customer does not pay, that profit will never convert into cash.
This gap explains why profitable companies can experience liquidity problems. Accounting profit measures the performance of the activity, while cash flow measures the real ability to pay. Therefore, accounting cash flow, although useful for comparing periods, has limitations that are important to know. For some purposes, it may suffice, but for planning payments, a direct estimate of cash flow is often needed, with expected collections and payments day by day or week by week.
Why it matters in daily management
As an organization grows, so do the challenges in controlling its cash. It is common for information to be spread across various banks, ERPs, spreadsheets, and, in groups with subsidiaries, different companies. When reconciliations are slow and data arrives outdated, forecasting becomes unreliable.
That is why more and more companies centralize their accounts and automate reconciliation, forecasting, and cash reports. Financial entities like BBVA offer solutions aimed at both large companies and SMEs and self-employed individuals to have a clearer view of their finances. The goal is not to replace analysis but to have up-to-date data to make decisions in advance.
In practice, understanding what cash flow is the first step to controlling the liquidity of any business. The second is to review it periodically, separating what the activity generates, what is invested, and what is financed, to know if the company can pay its debts without relying on the next round of credit.
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