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Accounting

What is Cash Flow?

Cash flow is the movement of money in and out of your business. Positive cash flow means more money coming in than going out.

Example

You might be profitable on paper but have negative cash flow if customers haven't paid yet.

Key Dates

Monitor continuously - cash flow problems kill businesses

How Cash Flow Works in Practice

Cash flow is the actual movement of money into and out of your company's bank accounts over a period of time. It is distinct from profit, which is an accounting concept based on accruals. Cash flow is concrete -- it is the money you can actually spend, pay suppliers with, and use to fund your business. More businesses fail due to cash flow problems than due to lack of profitability.

Cash flow is categorised into three types. Operating cash flow comes from your day-to-day business activities -- cash received from customers minus cash paid to suppliers, employees, and HMRC. Investing cash flow relates to buying or selling long-term assets like equipment, vehicles, or property. Financing cash flow covers borrowings, loan repayments, share issues, and dividends paid. Together, these three categories explain every pound that entered or left your bank account.

The gap between profit and cash flow catches many directors off guard. You can invoice £100,000 in December, report it as revenue, and show a profitable P&L. But if customers do not pay until March, you have no cash in December despite being "profitable." Meanwhile, your employees, landlord, and HMRC all want paying in real money, not accounting profit. This timing mismatch is the fundamental challenge of cash flow management.

For UK limited companies, a formal cash flow statement is only required for medium and large companies as part of their statutory accounts. Small companies are exempt from filing one with Companies House. However, every business should maintain a cash flow forecast as a management tool, regardless of whether it is required for filing purposes.

Step by Step

Cash flow is measured by tracking actual bank transactions over a period. The simplest approach is: Opening Bank Balance + Cash Received - Cash Paid = Closing Bank Balance. A positive cash flow means your closing balance is higher than your opening balance.

A cash flow forecast projects future cash movements based on expected income, committed expenditure, and known payment dates. It typically covers 13 weeks (rolling quarterly) or 12 months. You start with your current bank balance, add expected receipts (based on when customers are likely to pay), and deduct expected payments (salaries, rent, suppliers, tax). The resulting forecast shows when you might run short of cash.

The cash conversion cycle measures how quickly you turn business activity into cash. It considers how long stock sits in your warehouse, how long customers take to pay you, and how long you take to pay suppliers. Shortening this cycle (faster customer payments, slower supplier payments, less stock) improves cash flow without changing profitability.

Practical Tips

  • Maintain a rolling 13-week cash flow forecast and update it weekly -- this is the single most important financial management tool for a small business
  • Invoice promptly and chase late payments systematically -- every extra day your customer takes to pay costs you money
  • Include all known future payments in your forecast: Corporation Tax (9 months after year end), VAT (quarterly), PAYE (monthly), annual insurance, rent
  • If cash flow is consistently tight, consider invoice factoring or a business overdraft facility as a safety net rather than waiting for a crisis

Common Mistakes to Avoid

  • Assuming that profitable means cash-rich -- a fast-growing profitable business can easily run out of cash
  • Not maintaining a cash flow forecast and only discovering cash shortfalls when they happen
  • Forgetting to include large periodic payments like Corporation Tax, VAT, and annual insurance in the forecast
  • Paying suppliers immediately while giving customers 30-60 day payment terms, creating a permanent cash flow gap

Frequently Asked Questions

Why is my company profitable but has no cash?

The most common reasons are: accounts receivable (customers owe you money), stock purchases tying up cash, capital expenditure (buying assets), Corporation Tax and VAT payments, and loan repayments. Profit is an accounting measure; cash flow is real money in your bank.

How far ahead should I forecast cash flow?

A rolling 13-week (quarterly) forecast gives good short-term visibility. A 12-month forecast is valuable for planning larger expenditure and tax payments. Update your forecast weekly in the short term and monthly further out.

What is the difference between cash flow and profit?

Profit is calculated using accruals accounting, recognising income when earned and expenses when incurred. Cash flow tracks actual money movements. They differ because of timing (customers pay late), capital expenditure (not on P&L but uses cash), depreciation (on P&L but not a cash cost), and loan movements.

Do I need a cash flow statement in my statutory accounts?

Small companies (turnover under £10.2m, assets under £5.1m, under 50 employees) are exempt from including a cash flow statement in their Companies House filing. However, maintaining one internally is strongly recommended as a management tool.

How can I improve my cash flow quickly?

Chase overdue invoices immediately. Shorten payment terms for new customers. Negotiate longer payment terms with suppliers. Reduce stock levels where possible. Consider invoice finance to get immediate cash against outstanding invoices. Timing VAT and tax payments optimally also helps.

Source: HMRC Business Income Manual - cash basis and accruals: https://www.gov.uk/hmrc-internal-manuals/business-income-manual/bim70000

Related Terms

Profit

Profit is what's left after deducting all business expenses from your turnover. Corporation Tax is calculated on profit, not turnover.

Working Capital

Working capital is current assets minus current liabilities. It's the money available for day-to-day operations.

Accounts Receivable (Debtors)

Accounts receivable is money owed to your company by customers who haven't paid their invoices yet. Also called debtors or trade debtors.

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