What is cash flow?
Published
Cash flow is the actual movement of money into and out of a business over a period. The cash flow statement explains the difference between the opening and closing bank balance, split across three activities: operating, investing, and financing.
The equations
Net change in cash = Operating CF + Investing CF + Financing CFClosing cash = Opening cash + Net change in cashIndirect method:Operating CF = Net profit + Non-cash charges (depreciation, provisions) − Increases in operating current assets + Increases in operating current liabilitiesFree cash flow = Operating CF − Capital expenditure
Cash flow statement - Al-Waha, Q2 2026
| Line | SAR |
|---|---|
| Operating activities | |
| Net profit | 27,250 |
| + Depreciation (non-cash) | 5,750 |
| + Increase in end-of-service provision (non-cash) | 5,400 |
| − Increase in receivables | (22,450) |
| − Increase in inventory | (22,800) |
| − Increase in input VAT | (4,700) |
| + Increase in payables | 17,700 |
| + Increase in output VAT | 8,600 |
| Net operating cash flow | 14,750 |
| Investing activities | |
| Purchase of furniture and equipment | (5,750) |
| Net investing cash flow | (5,750) |
| Financing activities | |
| Owner's drawings | (18,000) |
| Net financing cash flow | (18,000) |
| Net change in cash | (9,000) |
| Opening bank balance | 191,400 |
| Closing bank balance | 182,400 |
The case that explains everything
Al-Waha earned SAR 27,250 in the quarter and its bank balance fell by SAR 9,000. A gap of 36,250. Where did it go?
Increase in receivables 22,450 ← sold but not collectedIncrease in inventory 22,800 ← bought but not soldIncrease in input VAT 4,700 ← tax paid, not yet recoveredOwner's drawings 18,000 ← left the businessEquipment purchase 5,750 ← cash converted into an asset ──────── 73,700 uses of cashProfit 27,250 + depreciation 5,750 + provision 5,400+ payables 17,700 + output VAT 8,600 = 64,700 sourcesNet: 64,700 − 73,700 = (9,000)
Nothing here is an accounting error or a fraud. A healthy growing business consumes cash: growth means larger receivables and larger inventory before the cash comes back. This is how profitable businesses go under.
Free cash flow
Free cash flow = 14,750 − 5,750 = SAR 9,000That is what actually remains after running the business and maintaining its assets. An uncomfortable observation: owner's drawings were SAR 18,000 - twice free cash flow. The owner is taking out more than the business generates, and the difference comes from accumulated balance. Sustainable for a while; not indefinitely.
The three activities
| Activity | Answers | Examples |
|---|---|---|
| Operating | Does the core business generate cash? | Customer collections, supplier payments, payroll, tax |
| Investing | What assets were bought or sold? | Equipment purchase, vehicle sale, property |
| Financing | Where did capital come from and go? | New loan, loan repayment, capital injection, drawings, dividends |
The healthy signal is consistently positive operating cash flow. A business with negative operating cash flow covering the gap from loans or capital is consuming itself.
Direct vs. indirect method
Indirect starts from net profit and adjusts for non-cash items and working capital movements. That is the method used above, and the more common one, because it builds directly from the income statement and balance sheet.
Direct lists actual cash receipts and payments: collected from customers, paid to suppliers, paid to employees. Clearer for a non-accountant, but it requires every cash movement to be classified.
Both methods produce the same bottom line.
Common mistakes
| Mistake | Why it's wrong |
|---|---|
| Reading the bank balance as a performance measure | The balance doesn't distinguish cash from collections, cash from a loan, and cash from stalling suppliers |
| Treating depreciation as a cash outflow | Depreciation is an accounting entry; the cash left when the asset was bought |
| Classifying owner's drawings as operating | Drawings are financing; putting them in operating hides whether the core business generates cash |
| Ignoring VAT in cash planning | Collected VAT isn't yours. In Al-Waha's case SAR 15,200 sits in the bank but is owed to ZATCA |
Frequently asked questions
Why am I profitable with no cash in the bank?
Because profit is measured on the accrual basis and cash on actual movement. The gap comes from uncollected receivables, accumulated inventory, drawings, and asset purchases. For Al-Waha the gap was SAR 36,250 in a single quarter.
What is the difference between cash flow and liquidity?
Cash flow is movement across a period. Liquidity is the ability to pay at a moment in time, measured by ratios such as the current and quick ratios.
Can operating cash flow be positive while the business is loss-making?
Yes, temporarily. It happens when collecting old receivables, liquidating stock, or delaying supplier payments. Those sources run out and don't offset a continuing loss.
How often should I review it?
Monthly as a report, and weekly as a four-week forward projection. Small businesses fail on the timing of cash far more often than on profitability.