Why was this page written?

Business literature is full of advices, for example, on starting a business. And you’ll find a wide range of terms, including “business idea” and “competitiveness.” Yet the core of business management often takes a back seat: profitability, liquidity, and stability. However, this website will focus solely on period liquidity. This is an area where you must judge for yourself which terms are useful and which are not. .

In 2024, the IASB (an accountants board) published IFRS 18. This subject is dealt with at the end of this page. In the file  'Business Management - Basics, Indicators and Planning Systems.PDF', you will find plenty of information on these subjects. You can downloud it

What is the difference between profitability, liquidity and stability?

Profitability shows whether a business's results are better or worse than expected. It is measured by the quantity of each factor engaged: Labour and capital (in agriculture, land is an additional factor). 

Liquidity must be maintained throughout the entire period (e.g. the whole year), on a daily basis. Checking liquidity should not only be done after the annual financial statement is ready. It is an ongoing challenge.

Stability can only be judged after the annual financial statement is ready. The most important criteria are debt coverage, the equity rate and equity growth.

Now, let us focus on period liquidity. For this, scientists have developed the 'cash flow for self-financing of investments', also known as 'cash flow 3'. This cash flow shows the 'self-financing capacity'. The staggered calculation from cash flow 1 to cash flow 3 has been taught to German agricultural students and master agriculture candidates for decades.

Cash flows 2 and 3 are also influenced by non-operational items. Cash flow 2 is available for repayments and investments. To achieve at this point adjusted deposits and adjusted withdrawals must be integrated. In large groups, annual dividends are withdrawals that limit the ability to finance investments. In family companies, household costs including nutrition, private insurance premiums and personal tax for the whole family must be considered.

For cash flow 3, repayments of debts must also be deducted. Useful benchmarks for cash flow 3 are so-called reinvestments. These are benchmarks for companies of all sizes. For this purpose, an approximate value is the total depreciation (including amortisation). For some reason, a better benchmark is often the depreciation of machinery and perennial crops in agriculture. If the inflation rate in a country is high, the reinvestment costs will exceed the depreciation. In this case, a surcharge can be added to the historical depreciation. Having a good understanding of cash flows can help avoid liquidity problems, or even illiquidity and bankruptcy.

Now, let us compare different cash flows. To do this, we will start by using the indirect method of cash flow determination. For this method, you need the ready annual P&L, which is already adjusted. This indirect method is generally preferred. The following diagrams remain the staggered derivation of cash flows 1 to 3. For more details, see 'i Business Management: Basics and Methods' PDF). 

Different cash flows including debt service limits

Free cash flow should provide an indication of how much can be paid out to shareholders in dividends. The definitions of free cash flow that can be found in literature do not take deposits and withdrawals into account. Consequences:
a) If investments are minor compared to the free cash flow, the company can pay huge dividends or withdrawals.
b) However, if investments are high, no dividends or withdrawals can be paid. It seems that the free cash flow is not a reliable indicator.

In German agriculture, at least, the term 'debt service limit' is widely used. However, the residual value only reflects long-term and medium-term benchmarks for cash flow 3. To reduce the number of terms a practitioner has to know, both of the following 'debt service limits' can be disregarded.

Liquidity terms : based on adjusted or on unadjusted figures?

There may be a discussion about whether the starting point for the definition of cash flow should be ordinary profit or the (unadjusted) profit itself. And whether incorporated deposits and withdrawals should be adjusted or not.

Well, the starting point for the 'debt service limit' has always been ordinary profit, adjusted deposits and withdrawals. The debt service limit should demonstrate the ability to generate sufficient funds without extraordinary cash inflows. Then, the analyst cash flows show sustainable values. The same applies to cash flows 1 to 3. 

However, when calculating liquidity in the short term, a different approach is required. Really, in short-term planning, extraordinary payments may have a significant impact. Thus, in an intra-year liquidity plan, cash flow 3 will be calculated twice, as shown in the following definition.

Others terms with the letters "cash flow" in its names

Discounted cash flow (DCF)

Although the DCF is a useful concept, it can only be used for future calculations. It involves discounting the estimated cash flows for subsequent years to their present value using financial mathematics. Therefore, DCF is not a means of analysing annual financial statements. DCF is just for planning! It shows profitability more than liquidity.

Cash flow statement

"Capital flow accounting" was already well known in the 1970s. It showed where capital came from (including new capital from loans) and where it went. It was constructed within the convention of "debit" and "credit". The totals on the left and right were equal. However, this system was not well received. Apart from accountants, it was almost forgotten. Later on, the term 'cash flow statement' emerged in the United States. Currently, the International Accounting Standards Board (IASB), an international but private association (to which the United States does not belong), has incorporated the cash flow statement into its International Financial Reporting Standards (IFRS). Note: the cash flow statement is not part of the 'family of scientific cash flows' shown above. It is not an incator of liquidity!

Perhaps it is a pitty, that the experts of business menagement use also the name "cash flow". Would it have been better to name the chain "cash surplus 1, cash surplus 2, cash surplus 3 ? As the saying goes: "The wiser one gives in". At least, it is confusing to call different things with the same name. 

IFRS 18 will change "cash flow statement" as well as "income statement" - just crazy !

The author researched the German BayWa Group found that the cash flow statement did not help BayWa avoid illiquidity. During his research, he came across IFRS 18, which was published in 2024. For a more detailed discussion, see section 4.4 of "i Business Management - Basics, Indicators, Exemples.pdf" and the article "i Stop the Three Activities according IFRS 18.pdf".

The IASB itself emphasises improvements for investors. IFRS 18 would lead to companies being valued more accurately. That is why the author also conducted research into how professional company valuers estimate values. It was found that some professionals use the equity rate or equity growth as the basis for their evaluations. Other professional evaluators use many terms that are already familiar from analyses. However, nobody takes cash flow statements into account! This paper ("Die Bewertung von Unternehmen geht anders.pdf", 2025) has not yet been published in English.

The cash flow statement is constructed with three layers, unlike the staggered cash flows shown above. New in IFRS 18 is that interest expense on loans is no longer deducted from 'cash flow from operating activities' as before. Now, this deduction has been transferred to 'cash flow from financial activities'. This change leads to confusion. However, some groups and companies may prefer this transfer because they can legally hide poor results.

The cash flows we discussed above are all based on money made by the company itself. However, in the cash flow statement, the total cash flow also includes cash from new debts. This implies that all expenses were funded through a combination of own funds and new debts. In fact, this is nonsense!

IFRS 18 will also affect the income statement (P&L). In future, profits will also be categorised according to three activities. As an analyst, you might think that these activities relate to labour remuneration. However, accountants use the term 'activity' to mean something completely different. Similarly to the cash flow statement, interest should be transferred to 'profit from financial activities'. This means that profit from operational activities will automatically be higher than before.

It's strange that a board of accountants is trying to dictate to entrepreneurs and other business management experts what should be regarded as 'standard'.

In 2024, PwC (PricewaterhouseCoopers) published an overview of the changes to the P&L statement due to IFRS 18. PwC is one of the major auditing firms.

There are a lot of changes in the income statement. However, there are no advantages for entrepreneurs. There is as well no advantage for investors when it comes to judging the value of a company.