Why build a direct cash flow?

A direct cash flow is one of the options that all organisations have to effectively manage their finances.

Unlike the indirect method, the flow of direct cash offers a clearer and more detailed vision of actual cash inflows and outflows.

This approach allows businesses to take more informed and proactive decisions about their liquidity, while improving the precision in their financial planning and its availability in real time.

 Below, we will explore the fundamental reasons why building a direct cash flow can be crucial to the success and financial sustainability of any organisation.

Seven reasons to use direct cash flow (and its advantages)

Still don’t know why to use direct cash flow? Let’s analyse its advantages.

1. Increased transparency in cash transactions

Direct cash flow is characterized by its ability to break down each cash transaction into specific categories, such as sales revenue, payments to suppliers, or operating expenses. 

This clarity allows companies to gain a detailed and accurate view of how and when cash is flowing in and out of the organization and thus accurately assess the efficiency of their day-to-day operations.

This level of transparency is critical for financial managers who want to better understand cash patterns. It also helps to avoid unwanted surprises, such as unexpected cash shortfalls, by having comprehensive control over all transactions.

2. Facilitates the taking of financial decisions

Having a detailed direct cash flow provides a solid basis for strategic financial decisions. Managers can use this information to plan investments, manage debt or adjust budgets more accurately. 

For example, if it is detected that future cash flows will be insufficient to cover the obligations, early action can be taken by renegotiating payment terms or seeking additional sources of financing. 

This proactive approach reduces the risk of facing liquidity problems and improves the company's ability to grow sustainably.

3. Improved liquidity planning

One of the most significant advantages of direct cash flow is its ability to show cash availability in real time. 

This approach is essential for liquidity planning, as it allows you to forecast exactly when and how much liquidity will be available to meet financial commitments, such as payroll, taxes, or suppliers. 

With this tool, companies can avoid situations of illiquidity that could compromise their operations or reputation.

In addition, sound liquidity planning based on straight cash flow can reduce the need to resort to emergency financing, which is often costly.

4. Helps in the detection of financial problems

Regular monitoring of direct cash flow enables companies to detect financial problems early. 

By observing patterns in cash inflows and outflows, managers can identify problem areas, such as a decline in sales or an unexpected increase in operating costs. 

For example, if a sustained drop in operating cash flow is detected, this could be an indication of problems in sales or operating efficiency. 

Recognizing these problems early provides the opportunity to implement corrective measures before they become serious threats to the company's financial stability.

5. Greater control over operating expenses

Direct cash flow allows companies to have tighter control over their operating expenses by detailing each cash disbursement accurately. 

This makes it easier to identify areas where expenses may be out of control or where there is room for efficiency improvements. 

For example, when analyzing direct cash flow, a company may discover that it is spending more than necessary on certain suppliers or that certain expenses are not generating the expected return.

With this information, it is possible to make informed decisions to reduce costs, renegotiate contracts, or even re-evaluate certain business strategies, thus optimizing the use of financial resources.

6. Facilitates the communication with investors and creditors

Direct cash flow is a very interesting tool for communicating the financial health of the company to investors and creditors 

By providing detailed and clear information on cash movements, stakeholders can more accurately assess the solvency and stability of the organisation

For investors, a positive and well-managed cash flow is an indication that the company is in a good position to generate sustainable returns 

For creditors, it’s a signal that the company can meet its payment obligations, which can make it easier to obtain financing on more favourable terms. Transparent communication based on a straightforward cash flow strengthens confidence and can open up new opportunities for financing and growth

7. Reinforces confidence in financial management

The consistent use of direct cash flow in the company’s financial management demonstrates a disciplined and proactive approach to resource management.

This methodology reinforces the confidence of all stakeholders, including employees, customers, investors and suppliers, in the company's ability to manage its cash efficiently. 

The objective is clear: sound financial management not only improves the external perception of the company, but also strengthens its internal culture by encouraging more rigorous and responsible cash management practices.

Ultimately, this confidence in financial management can translate into greater stability and long-term success for the organization.

For which companies is it best to use a direct cash flow?

Despite all the advantages offered by the direct method, it is not the ideal formula for all types of companies.

There are certain businesses that can benefit better than others from this type of formula. 

Here are some examples of them:

• Small businesses and startups: A local coffee shop that has recently opened its doors could use direct cash flow to track every daily sale and every expenditure on supplies and raw materials. This approach allows you to ensure that you always have enough cash to buy more coffee and pay employees on time, avoiding the need to resort to unnecessary borrowing.

• Businesses with variable cash flows: A tourism company that organizes adventure tours in specific seasons (such as safaris or winter excursions) may experience large revenue peaks during certain times of the year, followed by periods of low activity. Using direct cash flow allows you to plan for these cycles and ensure that peak season revenues cover costs during the off-season.

• Service businesses with regular billing: An accounting firm that sends monthly invoices to its clients for tax consulting services could use direct cash flow to synchronize cash inflows with its payroll and office rental payments. This ensures that cash is always available to cover fixed expenses without the need for external financing.

• Retail and FMCG companies: A supermarket chain that handles hundreds of daily transactions, all involving cash payments, can use direct cash flow to accurately track cash coming in and going out for product sales and vendor payments. This helps the company better manage its inventory, ensuring that shelves are always full without exceeding cash limits.

• Fast-growing companies: A technology startup that is rapidly expanding its presence in new markets could use direct cash flow to ensure that each new office or team hire does not compromise the company's liquidity. Using this methodology, it can balance the spending needed to grow with the need to maintain a healthy cash flow.

• Empresas con múltiples fuentes de ingresos: Una empresa de medios que opera tanto en televisión como en plataformas de streaming puede usar el flujo de caja directo para desglosar los ingresos que provienen de la publicidad televisiva frente a los de suscripciones online. Así, puede identificar qué segmento es más rentable y dónde enfocar sus esfuerzos de marketing y ventas.

• Empresas con estrategias de inversión activa: Una empresa inmobiliaria que invierte regularmente en la compra y desarrollo de propiedades puede utilizar el flujo de caja directo para evaluar la disponibilidad de efectivo antes de realizar nuevas adquisiciones. Esto asegura que no comprometa su liquidez en inversiones que podrían tardar en generar retornos, manteniendo así un equilibrio financiero saludable.

Final conclusions

In short, building a direct cash flow is an essential strategy for any company seeking to improve its financial management and ensure its long-term sustainability. 

This method offers unparalleled transparency by breaking down every cash inflow and outflow, especially when contrasted with other options such as indirect cash flow, facilitating informed and proactive decision-making.

Companies, regardless of their size or industry, benefit greatly from this tool, as it allows them to have tight control over their liquidity, detect financial problems early and communicate effectively with investors and creditors.

The importance of a treasury management solutions

Constructing a cash flow under the direct method is easier if the right tools are used. 

A comprehensive solution for corporate treasury management, such as Embat, significantly simplifies this process by automating data collection and detailed reporting on cash transactions. 

With the ability to integrate multiple data sources and deliver accurate forecasts, platforms like Embat make building and maintaining a direct cash flow accessible to any organization, regardless of size or complexity.