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Cash Flow Advisory: The Definitive Guide

Everything you ever needed to know, and more, about cash flow and cash flow advisory

By Kelvin Gieck | Updated April 16, 2021

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If there were a competition for the two most over-generalized yet ubiquitous terms in the accounting industry, “cash flow” and “advisory” would definitely be at the top of the list. Combine them together, and you have likely created the accounting equivalent of the Jackalope.

Wait a minute. Did I just date myself there? Probably.

For those of you who don’t know what a Jackalope is, you are either: “a” far younger than me, or “b” weren’t plugged into America’s Funniest People in any way, shape or form in the '90s.

If that’s piqued your interest you can check out a choppy VHS recording of what all the fuss is about here. If you don’t know what a VHS is… well... sigh.

All joking aside, I’ll pat myself on the back here and say that the Jackalope analogy is really striking. Let’s unpack it a bit. Jackalope: a mythical being of popular lore. Cash flow advisory: pretty much the same thing.

As a professional, you’ve likely read several in depth studies and attended many conventions where you were told that cash flow advisory was the solution to all of your, and your clients’ problems. It’s, apparently, the number one issue and concern of all small businesses. So if nothing else, it’s popular.

Now ask yourself, have you ever had a great explanation of what, exactly, cash flow advisory really is? Have you ever seen cash flow advisory really broken down? Probably not. So is it mythical? Absolutely.

So there you have it. Cash flow advisory is the accounting equivalent of a Jackalope.

And that’s precisely why we created this definitive guide. There shouldn't be this much confusion or mysticism around the topic for something so important to all small businesses and their trusted professionals. We’re going to lay out everything there is to know and break it all down. We’re going to give you a true, comprehensive understanding of everything related to cash flow and cash flow advisory.

We hope you enjoy it reading this guide as much as we enjoyed creating it.

Cash Flow: What Exactly Is It?

First things first, let’s actually dive into what cash flow is. This helps give us a little more context around why it’s essential and who exactly it’s important to (very cliche spoiler alert: it’s crucial to every small business).

 

What Is Cash Flow?

Wikipedia defines cash flow as: a real or virtual movement of money...

That’s probably not the most enlightening definition of cash flow we’ve ever heard. But if one reads on, we see another section on Wikipedia called Cash Flow Analysis. Here we can see contributors defining cash flow as a measure that helps:

  • Assess business liquidity
  • As an alternative measure to business profits
  • As a measure of the quality of the profits of a business

It is also something that is “loosely” based on cash flow statement accounting standards and is very fluid in time and measure...

Are we picking on Wikipedia here? Absolutely.

The funny part is that nothing in Wikipedia is incorrect. It is 100% spot on. But what it shows is how overcomplicated we (as in the human race) can make something.

So let’s hone in on it more and really try to define cash flow in a simple and valuable way.

 

What Is Cash Flow? The Simplified Version

Credit where it’s due, Investopedia probably has the most concise definition of cash flow we have seen. The writer, Adam Hayes, does a great job of summarizing it at a basic level:

“Cash flows are the net amount of cash and cash-equivalents being transferred into and out of a business. Cash received are inflows, and money spent are outflows.”

He furthers this by stating that:

“At a fundamental level, a company’s ability to create value for shareholders is determined by its ability to generate positive cash flows.”

So while cash flow is related to everything Wikipedia described, liquidity, profits, accounting standards and more, it is genuinely just a measure of the cash that comes into and out of any business. And the more of it you have, the better off your business is.

Why overcomplicate it. Cash flow is simply the amount of money that flows into and out of a business. And the more of it, the merrier.

 

Cash Flow: What Exactly It Isn't

Okay, so now we have a simplified definition of cash flow. But what about all these other terms that are used to assess cash flow? Operating cash flow, free cash flow, EBITDA. We can even see with Wikipedia’s definition that some tie cash flow to net profit.

Why is this?

Firstly, because cash flow is the single most crucial measure in business, a company will surely fail without positive cash and positive cash flow. Secondly, because industries are very different in form and function, cash flow can mean different things to different people. Some, for example, need inventory while others don’t. Having cash flow definitions that encompass these, while likely overwhelming, is actually helpful.

And of course, once you start to throw in technical accounting concepts and different levels of experience and expertise within a business’ management, the variety of ways that cash flow can be described becomes… well… a lot more varied.

This is likely why there is so much mystique and confusion around cash flow. There are just simply too many measures and contexts.

Being THE definitive guide to cash flow advisory, it would be a disservice if we didn’t cover some of the nomenclature and nuances in our space. So, let’s dig into what these specialized terms are and how they relate to our simplified definition of cash flow.

Disclaimer: We appreciate that many professionals out there may be well beyond these comparisons, but at the very least, it’s a good refresher as to questions our clients might have around cash flow.

 

Are Cash Flow And Income The Same?

Some might read this and ask why this comparison is even in our guide. The reality is that it’s a bit of a trick question. Why? We have seen it where even astute business owners refer to income and net income interchangeably in our experience. So we have given it a place within our definitive guide to dispel all incorrect notions.

The reality is that income is the very top line on your profit and loss statement (aka the income statement). It’s revenue, sales, or any other income that flows into your business.

If we broke cash flow down into a simple equation, it would be:

Cash Flow = Cash In - Cash Out

Income only accounts for money that flows into a business. This means we are missing an entire section of our cash flow equation.

So, there you have it, cross one-off, cash flow and income are not the same things.

 

Are Cash Flow And Net Profit (or Net Income or Net Earnings) The Same?

Let’s start off by defining net profit: income less any costs associated with that income. Put another way is any sales less cost of goods sold, operating expenses, general and administrative expenses, depreciation, interest, taxes, and other expenses.

To keep it really simple, we’re going to tell you that net profit and cash flow are not the same. But is that right?

 

Cash Flow, Net Profit And Cash Based Accounting

Some would posit that net profit equals cash flow when a business uses cash-based accounting.

What is cash-based accounting? It’s when revenues and costs are recorded as the related cash is received or paid. So when someone pays a company for work carried out, revenue is recorded. When the business physically pays a bill, expenses are incurred.

If we were to take the above paragraph at face value, one could see how cash-based net profit could equal cash flow.

Cash-Based Net Profit = Revenue - Expenses

Cash Flow = Cash In - Cash Out

Not to get too nerdy, but this would mean that we are completely ignoring any balance sheet activity. Items like inventory, building and machinery purchases are not included in the income statement. Loans received and subsequent principal repayments are also not included in the profit and loss. If any of these occur, cash-based net profit does not equal cash flow.

And when we say “any of these,” we mean any change that would occur on a balance sheet account that isn’t cash. So an easy rule of thumb to remember: balance sheet activity breaks any ties between cash-based net income and cash flow.

 

Cash Flow, Net Profit And Accrual Based Accounting

Having covered off cash flow in the context of cash-based accounting, it only fits that we do the same with accrual-based accounting methods.

Accrual accounting differs from cash-based accounting as it measures a company's financial performance and position by recognizing economic events when they are earned, not when cash changes hand. Revenue, as an example, is recorded when work is carried out, and the money becomes owned, not necessarily when it is actually paid. The same is true of expenses.

So without a shadow of a doubt, in an accrual world, net profit does not equal cash flow.

Not getting paid for work you have done right away? It is an accrual world.

Interestingly enough, the difference between cash flow and net income, in an accrual setting, is compounded even further due to the use of technical accounting concepts like “matching.” This gives rise to line items like prepaid expenses and unearned revenues. In these cases, cash changes hands in large lump sums but is then “realized” over time to properly match economic activity to actual work.

This is taken a step further with non-cash charges like depreciation. Conceptually, depreciation is extremely useful as it illustrates the wear and tear of an asset over time. A cost that often goes unseen. However, in real cash terms, you buy an asset then sell it (or dispose of it in some fashion). During the time in between, no money has changed hands.

Ironically, it seems the more “accurate” we make our financial statements, the more we detach them from the cash flow reality that is more relatable to most business owners.

Ever have a client ask why their net income was so high but their bank account is empty? [Everyone raises their hand] 

 

Are Cash Flow And EBITDA The Same?

Having thoroughly gone through the comparison of net profit and cash flow, let’s move on to “more comparable terms.” A great start here is to look at EBITDA relative to cash flow.

For those who don’t know what EBITDA is, it stands for “earnings before interest, taxes and depreciation.” Because it adds back items like financing costs (aka interest) and non-cash charges (aka depreciation) to net profit, it is commonly used as a proxy for operating cash flow.

But as the name implies, and the statement above alludes to, EBITDA ignores some real cash outflows. Banks like to collect their interest payments with legal tender, and governments certainly love to collect the taxes businesses owe them. What is it that they say about the two certainties in life?

I suppose a third is that EBITDA and cash flow are not the same, given that one ignores said cash outflows.

 

Are Cash Flow And Operating Cash Flow The Same?

Of course, our discussion of EBITDA above is an excellent lead-in to the question: is operating cash flow the same as cash flow?

The answer here is maybe a bit obvious. The fact that we are describing cash flow as “operating” could lead one to believe that there are likely other forms. And there are, namely, those that also show up on a traditional statement of cash flows (you know, that third piece to the financial statements that often is never created because it takes too much time?).

A traditional cash flow statement is comprised of:

  • Cash flow from operations
  • Cash flow from investing
  • Cash flow from financing

This allows readers of financial statements to see very clearly how cash was generated from, or lost in, various segments of business activities. Adapting our simplified cash flow formula to these terms, we would get:

Cash Flow = Cash Flow from Operations + Cash Flow from Investing
+ Cash Flow from Financing

This, of course, means that cash flow and operating cash flow are different. The latter being one component, out of three, of the former.

So why do people refer to operating cash flow so much? Simply because it is the primary driver of business activity and the core focus of operations. Having a handle on your operating cash flow, and ensuring it is consistently positive, ensures that your business remains a going concern. Given that, the terms cash flow and cash flow from operations are often used interchangeably in many business settings… even though it is definitely incorrect.

 

Are Cash Flow And Free Cash Flow The Same?

Ahhhh, Free Cash Flow. How I adore thee.

No, I really do. As a CFA Charterholder, I was trained from a young age to boil everything down to free cash flow, plunk that into my discounted cash flow models, and ultimately determine the worth of the asset I was analyzing.

In all of the discussions we have had to this point, most terms related to cash flow have focussed on operating activities. Put another way, the definitions all ignored critical cash inflows and outflows related to capital assets and financing activities.

The concept of free cash flow solves this problem… well, kind of… actually, not really.

Going back to our friends at Investopedia, free cash flow:

“Represents the cash a company generates after accounting for cash outflows to support operations and maintain its capital assets. Unlike earnings or net income, free cash flow is a measure of profitability that excludes the non-cash expenses of the income statement and includes spending on equipment and assets as well as changes in working capital from the balance sheet.”

Remember our cash flow formula for the traditional cash flow statement?

Cash Flow = Cash Flow from Operations + Cash Flow from Investing
+ Cash Flow from Financing

Free cash flow puts a different spin on it:

[Free] Cash Flow = Cash Flow from Operations + [Some] Cash Flow from Investing
+ Cash Flow from Financing

Where “some cash flow from investing” is any spending that occurs on equipment a business needs to sustain operations. So:

Free Cash Flow = Cash Flow from Operations
- Required Capital Spending (Cash Outflows from Investing)

Free cash flow is much closer to our simple cash flow definition than other terms we have gone over. But, it was designed to illustrate how much cash a business could generate on an ongoing basis for its shareholders so nerdy financial analysts could determine the fair value of stock prices.

Given that free cash flow ignores some capital inflows and outflows and all cash effects of financing, it too is a very different measure than our simplified definition of cash flow.