Why the cash flow statement is an essential tool
Theory and practice
The balance sheet and the profit and loss account say a great deal about a company.
But there is one document that is all too often underestimated and that is, in fact, decisive for understanding the real health of a business: the cash flow statement.
The profit and loss account tells you whether the company is making a profit or a loss. The balance sheet shows what its assets and liabilities consist of. The cash flow statement, on the other hand, explains where the money comes from and how it is used.
You can close a year with a positive profit and, at the same time, not have enough liquidity to pay suppliers, wages or taxes as they fall due. When cash is lacking, profit alone is not enough. There is no oxygen.
The cash flow statement tells you something fundamental: whether and how the business generates real liquidity. Many business crises start right here: accounting profits that do not turn into available money, and it is precisely this imbalance that often puts even apparently profitable companies in difficulty.
There are two main methods for building it.
Direct method
It shows actual receipts and payments at a glance. It is intuitive but little used in practice.
Indirect method
This is the most widely used method. It starts from the profit for the year and adjusts it by taking into account:
- non-cash items such as depreciation and provisions;
- changes in receivables, payables and inventory;
- investments and financing.
This reveals the real movement of the company’s cash.
A practical example
Let’s imagine a business with the following figures. Net profit: €100,000 Depreciation: €30,000 Increase in trade receivables: €40,000 Decrease in trade payables: €20,000 Purchase of machinery: €50,000 New bank loan: €60,000
Here is what happens.
Operating cash flow: +100,000 profit +30,000 depreciation −40,000 trade receivables −20,000 trade payables = +€70,000
Investing activities: −€50,000 for the machine
Financing activities: +€60,000 of new financing
Final result: liquidity increases by €80,000.
This means that, despite the significant investment, the company is still generating cash thanks to its operating and financial management.
That is why the cash flow statement is so important: it is not just a legal requirement but a strategic tool that helps you understand:
- whether the company generates or consumes cash;
- whether investments are sustainable;
- whether the financial structure is balanced.
Many business owners look at profit first. The soundest companies look at cash first.
Because you can have excellent margins and still find yourself in financial difficulty if liquidity is not managed properly.
So the real question is: are you really monitoring your business’s ability to generate liquidity… or are you only looking at the profit figure?