What is positive cash flow and why does it matter?

Revolut Contributor

 · 07/29/2020  · 07/29/2020

Positive cash flow means that the net balance of the cash flow statement of a business over a given period is greater than zero. In other words, the cumulative effect of the total cash inflows and outflows over this timeframe is positive rather than negative, and so the business is growing its cash reserves.

To define positive cash flow in more detail, we must first grasp the premise of the cash flow statement.  This document reveals the amount of cash that’s available to a business over a period – for instance, a quarter or a year – and measures liquidity by comparing the influxes of cash to outgoing cash flows.

What is positive and negative cash flow?

Each statement shows the cash balance of the business at the start and finish of the period it covers. In simple terms, this balance is the amount of cash held in the bank. That said, a cash flow statement should also include near-cash assets (i.e. anything readily convertible to known amounts of cash, such as bonds or hunks of gold bullion).

If the net effect of these movements reveals the business has increased its cash balance, then it is cash-flow positive. Conversely, if the balance is diminishing, then the business is cash-flow negative.

Why is a positive cash flow important?

Positive cash flow indicates that the business is liquid. This metric means it has enough working capital to cover its bills and will not require additional funding over the period that a statement covers. Another casual inference from a consistently positive cash balance is that the business will add to its assets and swell the value of these for shareholders. In many situations, this is true.

Before the business owners celebrate with a cake and balloons, they should reflect on whether this specific metric might inadvertently mask a malady. For starters, a positive cash flow doesn’t prove that the business is profitable. The surplus liquidity could be due to factors irrelevant to profit, such as the influx of loan capital or cash receipts for selling-off stock at a loss. Another point to consider here is dividends to shareholders, which might be declared but not yet paid out.

You can gain a broader perspective about the business by closer inspection of the details in its cash position. The obvious place to begin is to peek at all three sections of the cash flow statement.

  • Operating cash flow (i.e. activities related to operations e.g. sales revenue or supplier costs)
  • Investing cash flow (i.e. activities related to investment e.g. purchase or sale of machinery)
  • Financing cash flow (i.e. activities related to providers of capital e.g. long-term loans)

Even a swift glance at these categories will show if the business has a positive cash flow due to its core operating activities or because it has drawn-down funds created by a financing round.

How do you achieve a positive cash flow?

There are numerous ways for a business to achieve a positive cash flow – and not all of them are healthy. For instance, if the management is selling assets below market value merely to gain liquidity, this can easily create a positive cash flow, and yet it does not bode well for the future of the business.

In a similar vein, if the managers are ignoring an urgent need to invest in new machinery due to its hefty cost, this might create a positive cash flow in the short-term at the expense of long-term viability.

To some degree, this reveals the limitations of cash flow analysis, which we discuss here.

The takeaway is to be wary of metrics, such as positive cash flow, which can prove a blunt instrument. While it’s handy to see whether a business can cover its current liabilities without dipping into its cash reserves, there is often greater value in more nuanced profit metrics. Chief among these is a positive free cash flow. Until then, perhaps hold back on that cake and balloons.

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