Cash Flow Positive

What does cash flow positive mean?

Cash flow positive (German cashflow-positiv) describes a company whose receipts in a period exceed its payments, so that its liquid funds increase without an inflow of new equity or debt capital. Cash flow here means the balance of receipts and payments in a period. In common usage, the statement refers to operating cash flow, that is, the cash flow from ongoing business activity, and in a stricter sense to cash flow after investments.

The term is not a legal term but a position statement. For growth companies, it marks the transition from dependence on funding rounds to financing from their own resources. It appears in investor reports, in presentations for funding rounds and in sale documents. It is verified against the cash flow statement, which separates cash flows into operating, investing and financing activities. The term is also used for let property: a property is cash flow positive if its rental income exceeds all running costs including interest and repayment.

Which cash flow is meant

A statement about cash flow is meaningful only if the level is stated:

• Operating cash flow: balance of payments from ongoing business, that is, customer payments less payments for personnel, materials, rent and taxes. If it is positive, the ongoing operation pays for itself.
• Cash flow after investments: operating cash flow less payments for equipment, software and capitalised development. It corresponds to free cash flow and shows whether the company also finances its investments itself.
• Total cash flow: the change in liquid funds including capital increases, loans and repayments. A positive value after a funding round says nothing about the sustainability of the business.

Growth companies often reach a positive operating cash flow first, while cash flow after investments remains negative. That is unproblematic as long as the investments are planned and financed.

Cash flow positive or profitable: the difference

Profitability is a figure from the income statement: earnings before interest, taxes, depreciation and amortisation (EBITDA), operating profit or net income for the year. Break-even is reached when revenue covers expenses. Cash flow and earnings diverge for several reasons:

• Prepayments from customers increase funds immediately but are recognised as revenue only over the term. Until then, they stand as deferred income in the balance sheet (Section 250(2) of the German Commercial Code, HGB).
• Rising receivables and inventories tie up funds even though the revenue is already in earnings.
• Depreciation reduces earnings without a payment, investments and repayments are payments without immediate expense.

A company can therefore be profitable and cash flow negative at the same time, for example with rapid growth and long payment terms. Conversely, a software vendor with annual prepayments can report a loss and yet build up funds.

Significance in a funding round and a company sale

A company whose operating cash flow also covers investments and debt service (interest and repayment) does not depend on the close of the next round. Its runway is then arithmetically unlimited, and it can turn down offers without endangering its continued existence. Whether a company reaches this point with the funds it has is described by the term default alive.

Investors also ask at what price the positive cash flow was reached. If growth is put on hold to reach the metric, this can reduce the valuation of a growth company. Metrics such as the Rule of 40 therefore consider growth and margin together. By this rule of thumb, revenue growth and margin, for example the free cash flow margin, should together amount to at least 40%. In a company sale, acquirers adjust operating cash flow for one-off effects, for example stretched supplier payments or customer payments brought forward before the reference date. Such effects also feed into the determination of working capital, which the purchase agreement uses as a reference value.

Worked example: cash flow positive despite a loss

A software vendor reports EUR 2.4 million in revenue and EUR 2.7 million in expenses for a financial year, including EUR 100,000 of depreciation. Many customers pay annual contracts in advance.

• Net income for the year: 2,400,000 minus 2,700,000 = minus EUR 300,000
• Depreciation: plus EUR 100,000
• Increase in prepayments received (deferred income): plus EUR 500,000
• Increase in receivables: minus EUR 50,000
• Operating cash flow: minus 300,000 + 100,000 + 500,000 minus 50,000 = EUR 250,000
• Investments in hardware and software: minus EUR 350,000
• Cash flow after investments: 250,000 minus 350,000 = minus EUR 100,000

The company is operationally cash flow positive even though it reports a loss, and after investments still cash flow negative. The positive figure rests entirely on the increased prepayments: without them, operating cash flow would be minus EUR 250,000. If new business stagnates, this effect falls away, and operating cash flow converges towards earnings.

Distinction: operating cash flow, free cash flow and break-even

• Operating cash flow: the measure to which the statement usually refers. Cash flow positive is not a value of its own but the state in which this figure is positive over a period.
• Free cash flow: operating cash flow after investments. A positive free cash flow is the stricter form of cash flow positive.
• Break-even: the point at which the result of the income statement is balanced. It can lie before or after the point from which cash flow is positive.
• Default alive: describes whether a company reaches a positive cash flow before its liquidity is used up.

Common mistakes

• Level not stated. Anyone who speaks of a positive cash flow without qualification and means the inflow from a funding round loses credibility in due diligence.
• A single month generalised. A month with several annual prepayments is not a state. A moving average over three or twelve months is meaningful.
• Working capital effects presented as earning power. Delayed supplier payments or sold receivables improve cash flow once, not permanently.
• Earnings and cash flow equated. A positive EBITDA does not evidence a positive cash flow as long as receivables, inventories and investments grow.

Frequently asked questions

Is cash flow positive the same as profitable?

No. Profitable refers to the result of the income statement, cash flow positive to the cash flows. Prepayments, payment terms, investments and depreciation make the two diverge.

What comes first, break-even or positive cash flow?

That depends on the business model. If customers pay annual contracts in advance, a company often becomes cash flow positive before it reaches break-even. If growth ties up a lot of capital in receivables and inventories, break-even usually comes before positive cash flow.

Must a growth company be cash flow positive?

Not necessarily. A negative cash flow is acceptable if it rests on planned growth investments and financing is secured until the next milestone.

Which period is decisive for the statement?

As a rule the last twelve months or a moving average over three months. Individual months fluctuate too much with payment dates and prepayments.

How can operating cash flow be improved in the short term?

Above all through working capital: prepayments in return for a discount, shorter payment terms, a binding dunning process and making full use of supplier payment terms, provided no cash discount is lost in doing so. These levers act faster than cost reductions but usually only once.

The Roemer Capital view

If a client speaks of a positive cash flow in its documents, we jointly determine which level is meant and evidence it with the cash flow statement for the last twelve months. In a sale process, we adjust operating cash flow for one-off effects before an acquirer does so in due diligence.

An operating cash flow that carries interest and repayment makes a company able to take on debt capital: it can service loans. Investors also ask whether it is investable, that is, whether it can grow disproportionately with additional capital. We show both separately in the equity story, the rationale for the investment.