When you say cash flow, most entrepreneurs think of an Excel spreadsheet, a report from an accounting program or a nervous glance at the bank account a few days before payday. But few people associate cash flow with the law. Yet a company’s cash flow often determines whether you end up as a successful entrepreneur or in insolvency, whether you will be liable only for the company’s assets or also for your own home, and whether the tax authorities will come after you personally.
In this article, we will first explain what cash flow is and how it differs from ordinary profit. We will follow up by explaining exactly what operating cash flow means and why it is crucial to the day-to-day survival of a business. We will also show how cash flow relates to insolvency and the obligation to file for insolvency, the point at which it is no longer just an economic problem, but also a legal obligation. Finally, we will explain why monitoring and managing cash flow is part of the due diligence process and how it can help you avoid personal liability for company debts.
Cash flow, or cash flow, is essentially the movement of money in and out of your account. Cash flow is actually the difference between cash receipts and cash disbursements over a period of time – typically a month or a year. While profit is an accounting variable (revenue minus expenses), cash flow tells you how much money actually flowed in and out. So it could be that you have a profit according to your books, but at the same time your bank account is empty. Typically if you invoice a lot but customers pay late, spend on inventory, investments or paying off old debts, or have high loan and lease payments.
So, in practice, while profits look nice on the annual report, cash flow determines whether you pay wages, VAT and rent tomorrow. This is also important from a legislative point of view – the law does not address whether you are in profit on paper, but whether you pay your debts on time.
In practice, cash flow is commonly divided into three components:
Operating cash flow represents money from the day-to-day operations of the business – that is, collections of invoices, payments to suppliers, employee wages, tax payments, utility payments and other day-to-day expenses and income. This is what shows to what extent the company is able to “support itself”, i. e. to operate from its own operations without the constant replenishment of foreign money in the form of loans or extraordinary contributions from shareholders.
If you have a long-term negative operating cash flow, it means that the operation of the company itself consumes money rather than earns it. From a legal perspective, therefore, it is operating cash flow that is key to assessing whether a business is viable. If a company is unable to generate cash from current operations over the long term to pay its liabilities, it is only a matter of time before it goes bankrupt.
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Investment cash flow captures the cash associated with the purchase and sale of fixed assets. Typically, this involves the purchase or sale of machinery, technology, automobiles, real estate, or perhaps shares in other companies. When investment cash flow comes out negative, it doesn’t automatically mean there’s a problem – it often simply means that the company is investing in its development.
However, from a legal and economic point of view, it is important that these investments do not jeopardise the company’s ability to pay current liabilities – i.e. that one large investment does not leave wages, taxes or supplier invoices hanging.
Financial cash flow refers to how the company is financed externally. This includes primarily income from loans and borrowings, shareholder deposits, proceeds from the issue of shares or other securities, but also dividend payments to shareholders and principal repayments on loans. This component therefore shows when the firm receives money from creditors and owners and when it returns it.
From a legal and risk management perspective, it is essential that the company does not rely on funding from this component as the only means of survival – the long-term patching up of negative operating cash flow with new loans may in effect be an argument that the statutory bodies have merely postponed the inevitable and failed to react in time to impending bankruptcy.
What matters is how the three components of cash flow behave together. There may be a situation where a company is making a profit operationally, so has a positive operating cash flow, but drowns all its cash in investments. If the statutory bodies invest in this way without a sensible plan, thereby jeopardising the company’s ability to pay its liabilities, they may fall foul of the duty of care.
Conversely, it is not impossible that the company will temporarily have negative operating cash flow, but will cover it in a prudent and considered manner by external financing, for example, a loan or shareholder contributions. The important thing is to keep a close eye on the possibility of bankruptcy and to continuously assess whether such financing is still sustainable and legally safe.
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Many entrepreneurs look mainly at the income statement when assessing the health of a company and wonder whether they are reporting an accounting profit or loss. However, accounting works on the accrual basis, the principle that revenues and expenses are allocated to the period to which they are materially and temporally related, not to the time at which payment is made.
In practice, this means that you may have booked a large amount of revenue, but the money from the customer doesn’t arrive until several months later. Similarly, you may have an expense on the books but actually pay the supplier later – or, conversely, before the expense appears on the income statement. So the profit and loss account does not in itself answer the question of whether you will have enough money in your account tomorrow to pay your staff, VAT or invoices due; it only shows whether your business is accounting profitably. Cash flow, on the other hand, looks solely at the actual movement of money – what has actually flowed into the account and what has actually flowed out.
Example: let’s imagine an LLC that closes a large order for CZK 1,000,000 in January. It issues an invoice to the customer with a due date of 90 days. In January, the company already has a significant income in its income statement, and in the following months it incurs costs related to the contract. It is therefore in the black in both January and February. In reality, however, it has to pay wages to employees, rent, materials and energy from the first day and at the same time pay VAT on the invoice, even though the money from the customer does not arrive physically until sometime in April. If a company does not have sufficient operating cash flow or financial reserves, it can easily find itself in a situation where it is unable to pay its obligations on time. Outwardly, the income statement may still look rosy, but legally it may already be insolvent and bankrupt under the Insolvency Act. That is why it is so important not to rely only on the profit in the income statement, but to continuously monitor the cash flow, i.e. the actual cash flow of the company.
According to the Accounting Act, some accounting entities must prepare financial statements in the so-called full scope. Such statements include, among other things, a cash flow statement. This provides an overview of cash inflows and outflows and cash equivalents by activity group (operating, investing, financing).
The obligation to prepare a cash flow statement typically applies mainly to large and medium-sized entities, some public sector entities and those entities that are legally obliged to have their financial statements audited.
Even though small LLCs or sole proprietorships are usually not required to prepare a cash flow statement, it makes sense from a legal perspective to have it at least in internal form. Such a cash flow statement can become important evidence – for example, in a potential dispute over the liability of the managing director, in assessing whether the company was bankrupt and since when, or in proving that the managing director resolved the situation in a timely manner, whether by negotiating with the bank, financial restructuring or filing an insolvency petition.
From a legal point of view, the cash flow statement is extremely valuable primarily because it shows retrospectively when the company actually started to run into problems, i.e. from what point onwards the money was no longer sufficient to cover current liabilities. It is often on the basis of such a statement that the moment of insolvency can be determined quite accurately, which is crucial for assessing whether the statutory bodies filed an insolvency petition in time, as required by law.
At the same time, the cash flow statement can serve as evidence that the company’s management has continuously monitored the financial situation and taken specific measures – for example, negotiating with banks, preparing restructuring or considering various resolution options. This is crucial for assessing whether the managing director acted with due care.
In other words, a well-maintained and archived cash flow statement can literally save a CEO’s personal fortune one day – because it can prove that he or she made sound and informed decisions at a time when the company was in trouble.
Learn how to correctly file for insolvency.
According to the Insolvency Act, a debtor is insolvent if, among other things, it is insolvent – it has multiple creditors, monetary obligations more than 30 days past due and is unable to meet these obligations. Insolvency should be distinguished from mere insolvency – a situation where there is money but the debtor simply does not want to pay it.
There are several key implications for you as a business. It’s not enough to console yourself with the phrase: “We’re in the black on paper, cash flow will even out over time.” In fact, if you don’t have the money to pay your outstanding debts in the long term, the court may conclude that you are bankrupt, despite a nice-looking income statement. In other words, it’s not just the numbers on the financial statements that matter, but your actual ability to pay your debts on time.
Long-term negative operating cash flow is one of the main signals of insolvency. In practice, insolvency practitioners and experts often reconstruct the historical cash flow in order to document when the company was objectively no longer able to meet its obligations.
According to the Insolvency Act, a debtor that is a legal person or an entrepreneur has a duty to file an insolvency petition without undue delay after it became aware or, with due diligence, should have become aware of its insolvency. This obligation also applies to the statutory body of the company (typically the managing director of an LLC), who may be liable for damages to creditors if it is not fulfilled.
And where does cash flow play a role in all this? If operating cash flow is not forthcoming for a long time and the company is not paying its overdue liabilities, this is a strong signal that bankruptcy may have already occurred. In such a situation, the statutory body, which has the accounts and cash flow statements, usually cannot defend itself by saying that it did not know about the problem. The law requires him to exercise due diligence to become aware of the insolvency, i.e. to actively monitor and assess the financial situation.
Practically, this means that ignoring the numbers on the cash flow statement is legally very risky. Even if the company is still living off loans or delaying payments for some time, the reality of cash flow may later show in court that the insolvency petition should have come significantly earlier.
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Due diligence is a legal standard that requires a member of an elected body (e.g., an executive officer, a member of the board of directors) to perform his or her duties with loyalty, due skill and care. According to settled case law, it is not a duty to achieve a particular result, but a duty to behave reasonably, knowledgeably and prudently, as another prudent manager would behave in the same circumstances.
Both the Civil Code and the Corporations Act require that anyone accepting a position as a member of a body must undertake to perform that function. If he or she is not capable of such diligence, he or she should not accept the position at all – otherwise he or she is liable for damages.
The care of a good steward includes not only formal oversight of the company, but also active monitoring of its financial situation, early recognition of impending insolvency and the ability to assess the risks of planned transactions, whether investments or new loans. Part of this duty is also to secure professional assistance if the statutory body does not dare to assess the situation itself (typically an accountant, tax advisor or lawyer).
In business, cash flow is one of the main tools to monitor these risks in a sensible way. If the managing director does not work with cash flow at all, does not know whether the company will have enough for salaries and VAT next month, and yet enters into other commitments, it is much easier to conclude that he or she is not acting with the necessary diligence.
By contrast, a managing director who has a regular overview of the operating cash flow, sees the deteriorating payment situation early on and demonstrably takes action – negotiating with the bank, adjusting maturities, and in the extreme case even preparing an insolvency petition – is in a much stronger position should someone later claim that he or she has behaved irresponsibly.
Cash flow is not just an accounting or management discipline, but a very practical subject that plays a vital role in ordinary commercial contracts. Every agreement on price, maturity or penalty has a direct impact on when money flows in and out, and therefore on whether you have money to pay at any particular time.
From a healthy cash flow perspective, it makes a lot of sense not to sign long invoice terms unless you can realistically afford to wait several weeks or months for money. It’s better to arrange advances or interim payments so that cash flow is spread out and the business doesn’t have to fund the entire deal from its own resources or loans in the meantime. At the same time, you need to bear in mind that too strict contractual penalties against you can trigger an avalanche of problems in combination with poor cash flow – one delay, a high contractual penalty, and suddenly you lack funds for further obligations.
When negotiating contracts, it is therefore wise to do a simple cash flow scenario: think about when you will have to pay suppliers, employees or loan repayments and when you can realistically expect to receive income from your customers. If you can already see at the time of signing that the operating cash flow will be negative in the long term due to the set terms, it is a good idea to either adjust the contractual terms or look for other ways of financing.
An attorney can help you set up payment terms that are realistic with respect to your cash flow, and that the contract does not jeopardize the company’s liquidity at the first bump. He or she can also alert you to risky contractual arrangements, such as liquidated damages, which can quickly turn into a serious problem when combined with tight cash flow.
An attorney can also give you early warning of situations where contractual relationships are getting dangerously close to bankruptcy – for example, when you are committing to another large performance, but know that operating cash flow is not even sufficient to cover existing obligations. In practical terms, therefore, those who combine a legal perspective with cash flow management significantly reduce the risk of insolvency, foreclosure and personal liability of statutory bodies.
Cash flow shows the actual movement of money in a company and, unlike accounting profit, determines whether you pay wages and taxes today or start to fall into default and bankruptcy. In particular, operating cash flow is a litmus test of the viability of a business – if it is negative for a long time and the company can no longer manage to pay its debts, it is no longer just an economic problem, but also a risk of insolvency and the obligation to file for insolvency. It is then the cash flow statement that often decides in any litigation as to when the company has been insolvent and whether the statutory bodies reacted in time.
It is therefore part of the due diligence for managing directors and other statutory bodies. A regular review of cash flow, sensible investment and financing planning and realistic payment terms in contracts substantially reduce the risk of insolvency, foreclosure and personal liability for the company’s debts.
Cash flow describes the movement of money over time – that is, how much money flows in and out during a given period. Liquidity, on the other hand, describes how quickly you are able to convert assets into cash to pay your liabilities (e.g. cash in the bank vs. inventory in stock).
Yes. Even profitable and capital-intensive companies can get into short-term payment distress – typically during large investments, seasonal fluctuations or unexpected customer outages. Cash flow lets you know early on that you’re going to fall below zero at some point, even though the aggregate results look good.
The statement should be prepared on a regular basis (e.g. once a month), linked to real accounting and banking documents, always properly dated and approved (e.g. by the signature of the managing director or by reference in the minutes of the meeting) and subsequently archived together with attachments such as bank statements and accounting exports. Such a statement can then demonstrate what your actual knowledge of the situation was at a particular time and that you made decisions based on that knowledge.
According to the Insolvency Act, the debtor is obliged to file an insolvency petition without undue delay after he became aware of his insolvency or, with due diligence, should have become aware of it. In the case of legal persons (e.g. s.r.o., a.s.), this obligation falls on the statutory body (executive, board of directors) and also on the liquidator if the company is in liquidation.
If you have regular cash flow statements, accounting and banking documents, the court typically assesses how a careful manager would have evaluated the situation under the same circumstances. If the statements have long shown an inability to meet obligations and you have taken no action, it is very difficult to make a plea of ignorance. The law requires you to exercise due diligence, i.e. actively monitoring your financial situation, not passively relying on things working out.
Not sure how to do your taxes correctly so you don’t get it wrong? We can help you navigate the law, whether it’s dealing with a specific tax situation, preparing for an audit by the tax authority or defending yourself in court.
Ondřej is the attorney who came up with the idea of providing legal services online. He's been earning his living through legal services for more than 10 years. He especially likes to help clients who may have given up hope in solving their legal issues at work, for example with real estate transfers or copyright licenses.
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