Direct cash flow calculation in COMMITLY

As the framework (template) for cash flow planning, COMMITLY uses the so-called direct cash flow calculation. In financial jargon this means that cash-effective income is netted against cash-effective expenditure. In plain English, it means that we calculate the available cash flow, also known as free cash flow, as the difference between the incoming and outgoing payments on the accounts connected to COMMITLY.

The scheme behind the direct cash flow calculation

In the calculation, the incoming and outgoing payments are divided into 3 groups:

A – Operating cash flow:

Operating cash flow shows whether your company is able to finance itself. If your ongoing income (incoming payments) over a given period is higher than your ongoing expenditure (outgoing payments), everything is in the green. Keep it up!

B – Cash flow from investing activities

This pot shows whether you have made investments for your company or purchased assets. If your cash flow from ongoing business activities is positive, i.e. money is available or left over, you have the option of making investments – for example buying a new workstation including a PC.

C – Cash flow from financing activities

This shows whether your company has taken out or repaid loans, made payouts to shareholders (dividends) or received contributions from shareholders. Any drawings beyond the owner’s salary also fall into this category. If your operating business activity delivers too little cash flow, you can also make investments out of this pot, for example with your business loan.

But why are these “pots” actually so important?

Because together they give the best possible picture of your company’s financial strength. In our example we have shown the best case: your business is going so well that you generate a surplus from your ongoing income, can invest and even have something left over. And what is left over is, by the way, the “free cash flow”.

A positive freely available cash flow / free cash flow

The positive “free cash flow” is yours to use as you wish. That means you have covered all ongoing expenditure, made investments and still have something left over. Congratulations!

What is the best thing to do with free cash flow?

• Build up a liquidity buffer as a precaution
• Invest in new projects or, say, new employees
• Repay loans early
• Take out profits
• …

What to do about a negative operating cash flow?

But what if your operating cash flow is negative, that is, if your expenditure (outgoing payments) is higher than your income (incoming payments)?

First: do not despair! Second: keep in mind that you are not alone with this problem! Almost every entrepreneur knows this situation: in one month the incoming payments are delayed and not all the outgoings can be paid smoothly.

Lucky is the one who has built up a liquidity buffer in previous periods. Then it is only a temporary liquidity squeeze. If not, the only thing that helps is cash flow from financing – in other words reaching into your own pockets or going to an investor or the bank.

So what measures can be taken?

• Check whether investments can be pushed back
• If there are realisable fixed assets, a sale (divestment) may also be worth examining.
• Financing – is there access to loans, subsidies or fresh equity
• Doing without drawings also falls within the area of financing

Does that mean COMMITLY relies exclusively on the bank accounts?

The short answer is: yes! And what about the data from the accounts? The main task of bookkeeping is to present the past in a legally correct way. Planning concerns the future, has no legal requirements AND you cannot “break” anything either. That is an important aspect, and one our customers point to as well. The well-known investor Fred Wilson has also described another very important aspect on his blog – different types of people. The finance function: looking back and looking forward

“In my experience, the people who are strong in the looking back function are often not strong in the looking forward function. You may need different people to take on these roles. In a large company there are quite different departments that handle these functions. There is an accounting department and a financial planning department (often called FP&A).”

Does that make COMMITLY useful only for cash-basis accounting?

No! Companies with double-entry bookkeeping have only limited insight into their cash flow from the accounts. That often leads to the indirect method being used to determine cash flow. The starting point is then the result for the period, and so-called non-cash items – that is, non-cash-effective income and expenses such as depreciation – are stripped out. On top of that you have the issue of accruals and deferrals. The indirect derivation is so complicated, however, that it is usually done by the tax advisor, with a corresponding time lag. BUT: a major tax advisor once told me that only 10% of HIS staff have any idea how it works.

Is the indirect calculation not better for larger companies after all?

The direct calculation, as used by COMMITLY, is super simple and covers all scenarios, all forms of accounting AND all company sizes. The “connecting piece”, if you like, is the cash position, i.e. the balance of the bank accounts. That is also what is special about COMMITLY. In practice we have rarely (in fact never) seen cash flow plans (or cash flow reports) in Excel that could be reconciled one-to-one with the accounts. COMMITLY guarantees this.

Why? Because at the end of a period the most important basis for a tax advisor (whether cash-basis or double-entry accounting) is the reconciliation with the bank account. And in COMMITLY that is guaranteed automatically.