What is cash flow?

Cash flow is the movement of money into and out of your business over a period. In one sentence: cash flow measures liquidity — whether you have cash available to pay bills, invest, and survive short-term shocks. Unlike accounting profit, which recognises revenue and expenses when earned or incurred, cash flow tracks actual receipts and payments. That difference matters because a profitable business can still run out of cash if receipts lag payments.

Cash flow can make or break a business: strong cash management helps you stay solvent, invest with confidence and negotiate better finance terms.

Why cash flow matters

Cash flow drives day-to-day survival and strategic choices. Key reasons it matters:

Liquidity: Cash on hand pays payroll, suppliers and tax. Without it you may need emergency funding.

Solvency: Persistent negative net cash flow can lead to insolvency even if the business is profitable on paper.

Investment decisions: Positive free cash flow funds capex, growth and dividends; negative free cash flow limits options.

Creditworthiness and covenants: Lenders assess cash flow to set limits and covenants; weak cash flow can increase borrowing costs.

Decision-making: Pricing, supplier terms and working capital policy are all shaped by cash realities.

When discussing your cash position with advisers, you'll often be asked for a rolling forecast or a recent cash flow statement.

Types of cash flow

Cash flows are grouped into three categories on the cash flow statement:

Operating cash flow (OCF)

Cash generated by core business activities: customer receipts, payments to suppliers and staff, GST remittances and other operating items. Example: receiving $120,000 from customers and paying $10,000 to suppliers and $10,000 in wages yields positive OCF.

Investing cash flow

Cash used for or received from long-term assets: purchases or sales of property, plant and equipment, investments and loans to others. Example: buying machinery for $10,000 is a cash outflow in investing activities.

Financing cash flow

Cash inflows and outflows from debt, equity and capital transactions: loan drawdowns, repayments, dividends and owner contributions. Example: a $100,000 bank loan drawdown is a financing inflow; quarterly loan repayments are financing outflows.

Understanding which activity drives your cash movements helps you decide whether to change operations, defer capex or adjust financing.

The cash flow statement — overview and standards

The cash flow statement explains changes in cash between two balance-sheet dates and complements the income statement and balance sheet. Its purpose is to show:

• Cash generated from operations
• Cash used in investing
• Cash from/used in financing
• Reconciliation to the opening and closing cash balances

Reporting guidance is set out in AASB 107 — Statement of Cash Flows. AASB 107 requires disclosure of the cash flows from operating, investing and financing activities, the reconciliation of profit to net cash from operating activities (if using the indirect method), and details of non-cash transactions and interest and tax paid.

Companies can present operating cash flow using either:

The direct method: lists major classes of gross cash receipts and payments (cash from customers, cash paid to suppliers, etc.).

The indirect method: starts with accounting profit and adjusts for non-cash items (depreciation, amortisation) and changes in working capital.

Both methods produce the same net operating cash flow once all adjustments and reconciling items are included. The direct method is often clearer for management and lenders.

How to calculate cash flow (formulas and methods)

Key formulas

Net Cash Flow = Cash Inflows − Cash Outflows

Free Cash Flow (FCF) = Operating Cash Flow − Capital Expenditure

Cash Conversion Cycle (CCC) = Days Inventory Outstanding + Days Sales Outstanding − Days Payable Outstanding

Direct vs indirect methods (operating cash flow)

Direct method: Sum of cash received from customers minus cash paid to suppliers, employees and others.

Indirect method: Start with net profit and adjust for non-cash items and working capital changes:

OCF (indirect) = Net Profit + Depreciation ± Working Capital Changes + Other Non-Cash Items

Worked numerical example (AUD)

Assume a four-week period with the following simplified accounting figures:

• Sales (accrual) for period: $150,000
• Cash received from customers: $120,000
• Payments to suppliers: $15,000 (cash)
• Wages paid: $10,000 (cash)
• Rent paid: $1,000
• Depreciation (non-cash): $1,000
• Capital expenditure (machinery purchase): $10,000
• Loan drawdown: $1
• Loan repayments (principal): $10,000

Direct method (Operating cash flow)

• Cash from customers: $120,000
• Cash to suppliers and employees: -$15,000
• Rent: -$1,000
• Operating cash flow (direct): $120,000 − $15,000 − $1,000 = $10,000

Indirect method (Operating cash flow)

• Net profit (accrual): suppose $10,000
• Add back depreciation (non-cash): +$1,000
• Subtract increase in receivables (accrual sales $150k vs cash receipts $120k = $10k increase): -$10,000
• OCF (indirect): $10,000 + $1,000 − $10,000 = $14,000

Note: In full reconciliation, after all accruals, tax and non-cash items are included, the indirect and direct OCF figures should align.

Free cash flow

FCF = OCF (direct example) − Capex = $10,000 − $10,000 = −$10,000

This business has negative free cash flow for the period, indicating capex is not covered by operating cash.

Cash flow forecasting — a simple step-by-step for SMEs

A rolling 13-week forecast gives short-term visibility and is standard for lenders and creditors.

Step-by-step guide

1. Choose horizon and frequency: 13 weeks, weekly updates, rolling forward by one week as each week ends.

2. Gather inputs: Opening cash balance, expected receipts from customer payment schedules and known contract milestones, expected payments including wages, supplier invoices, loan repayments, taxes and rent, and one-off items such as capex and dividends.

3. Build the template: Columns for week 1 to week 13, rows for opening balance, receipts categories, payments categories, net cash for week, and closing balance.

4. Make assumptions explicit: Days Sales Outstanding (DSO), percent of invoiced receipts collected weekly, payment terms with suppliers, and seasonality.

5. Scenario planning: Base case, downside (slower receipts) and upside (faster receipts or delayed capex). Track the weeks where closing balance dips to zero.

6. Review frequency and owners: Update weekly; CFO/owner reviews and updates assumptions when invoices are issued or terms change.

Example 4-week extract

A zero or negative closing balance alerts you to take action: accelerate receivables, delay discretionary payments or arrange short-term finance. For broader working capital strategy see Working capital.

How interest rates and inflation affect cash flow

Interest rate and inflation moves influence cash flow through several channels:

Interest expense: Variable-rate debt payments increase when central bank rates rise; that directly increases cash outflows for interest.

Refinancing risk: Higher rates raise the cost of new borrowing and can reduce access to credit.

Cost of goods: Inflation increases input costs, raising cash outlays for inventory and production.

Pricing power: If you can pass costs to customers through prices, cash outflows may be offset by increased receipts; if not, margins and cash suffer.

Working capital needs: Higher inventory costs and longer supplier lead times usually increase the cash required to operate.

Practical actions when rates and inflation rise:

• Lock fixed-rate debt for a portion of your borrowings.
• Revisit payment terms and pricing regularly.
• Tighten receivables collection and inventory turns.

See the interest guide for mechanics and borrower guidance.

Cash flow and credit/risk management

Lenders focus on cash flow because it shows the borrower's ability to service debt. Key lender considerations:

• Historical operating cash flow and trends.
• Forecasts (13-week or monthly) and downside scenarios.
• Liquidity cushions: undrawn facilities, cash reserves, asset realisations.
• Covenant ratios: interest cover, current ratio, leverage metrics.

To reduce credit risk and reassure lenders:

• Provide a clear rolling forecast and stress-tested scenarios.
• Maintain up-to-date aged receivables and payables reports.
• Negotiate flexible covenants or short-term relief when required.

External finance options commonly used to manage cash shortfalls include invoice finance, business overdrafts and lines of credit.

Key cash-flow KPIs and red flags

Monitor a small dashboard of KPIs:

Red flags:

• Repeatedly negative operating cash flow.
• Shrinking cash buffer (days cash on hand declining).
• Rapidly lengthening DSO or shrinking DPO without operational reason.
• Covenant breaches or frequent emergency borrowing.

Where appropriate, compare these KPIs with industry peers to benchmark your business performance.

Practical ways to improve cash flow

Prioritised tactics for SMEs:

1. Speed up receivables

Invoice immediately, use electronic invoicing and offer incentives for early payment. Use invoice discounting if you need immediate cash against invoices.

2. Manage inventory

Reduce safety stock with better forecasting; implement just-in-time where appropriate. Sell obsolete stock at discount to free cash.

3. Negotiate payables

Extend supplier terms without harming relationships; consolidate suppliers for leverage.

4. Control discretionary spending

Defer non-essential capex; evaluate long-term ROI before committing cash.

5. Review pricing and margins

Adjust pricing to reflect input-cost inflation while communicating value to customers.

6. Use short-term finance prudently

Facilities such as overdrafts or lines of credit are best for smoothing timing gaps, not permanent funding for operating losses. See Overdraft.

7. Improve forecasting and discipline

Maintain a rolling 13-week forecast and update it weekly to catch issues early.

8. Consider lease vs buy for capex

Compare equipment finance and lease alternatives to preserve cash.

When to consider external finance

Consider external funding when:

• Your forecast shows persistent or structural negative free cash flow.
• You have a temporary, identified timing gap (e.g., seasonal working capital pressure).
• You need to fund strategic capex with positive long-term returns.

Common options and trade-offs:

Overdrafts: Good for short timing gaps; variable cost and can be withdrawn.

Invoice finance: Converts receivables to immediate cash; reduces DSO but carries fees.

Line of credit: Flexible, interest on drawn amounts only.

Term loans: Better for capex; amortises principal over time with fixed schedule.

When approaching lenders, bring historical cash flows, a rolling forecast, collateral details and covenant proposals.

Key takeaways

Prioritise weekly forecasting, monitor a small set of cash-focused KPIs and act early on shortfalls. Strong cash flow protects liquidity, supports growth and improves lender confidence. Use short-term finance only to smooth timing gaps, not to subsidise ongoing losses.

Further reading

• AASB 107 — Statement of Cash Flows: https://www.aasb.gov.au/admin/file/content105/c9/AASB107_08-15_COMPmar16_01-17.pdf
• Business Victoria — Cash flow forecasting: https://business.vic.gov.au/business-information/finance/cash-flow/cash-flow-forecasting
• Reserve Bank of Australia: https://www.rba.gov.au
• ATO — Record-keeping for business: https://www.ato.gov.au/business/record-keeping-for-business/

FAQ

This article is general information only and is not legal, tax or financial advice.