What it means
The cash flow test is one of the two standard ways of judging whether a business is insolvent, the other being the balance sheet test, which compares what a company owns with what it owes. The cash flow version ignores the accounting value of assets and looks only at liquidity: money coming in the door against money going out of it.
This matters because most businesses that fail do not fail because their assets are worth too little. They fail because on a particular Friday there is not enough money in the bank to pay the wages, the supplier or the loan instalment.
Directors, lenders and boards therefore treat the cash flow test as the more urgent of the two warnings. In practice the test is applied over a rolling forward window, commonly thirteen weeks, because that is far enough ahead to see trouble and near enough to forecast with some confidence.
You list the opening bank balance, add receipts you genuinely expect to collect, then set that total against every payment contractually due in the window. If the obligations exceed the available cash at any point, the business fails the test for that period.
The judgement calls sit in the assumptions rather than the arithmetic. Receipts should be based on when customers actually pay rather than when invoices were raised, and an overdraft facility only counts as available cash if the bank is committed to keep it open.
Padding either side of the calculation is the most common way a failing business convinces itself it is fine. A serious version of the test also considers debts that will fall due slightly beyond the window, sometimes described as prospective liabilities, such as a bond maturing in eight months with no refinancing in place.
Courts and insolvency practitioners in several jurisdictions treat that kind of foreseeable wall of debt as relevant, so a narrow thirteen-week pass does not always mean the company is safe.
In practice
Real-world examples.
Example
A regional construction firm holds $2.1m of unbilled work in progress and looks healthy on its balance sheet, but its 13-week forecast shows a $340,000 gap in week six when a VAT payment and a subcontractor run land in the same fortnight. The finance director negotiates a staged payment plan before the gap arrives, which is the whole point of running the test early.
Example
A software company preparing to sign a new office lease runs a cash flow test that includes the deposit and the first year of rent. The test shows the company passes comfortably in every week except the month the deposit is paid, so it negotiates a smaller deposit backed by a guarantee.
Example
A family-owned food manufacturer is offered a large supermarket contract with 75-day payment terms. Its cash flow test shows that funding the ingredients and labour for that long would leave it $600,000 short in month four, so it accepts a smaller initial volume rather than winning the order and running out of money.
Think of it
“Cash flow test is a specific measurement to check if you meet a required cash flow standard.
Formula
Calculation
Available cash = opening cash balance + expected receipts in the period. Test result = available cash - obligations falling due in the same period. A positive result means the business passes; a negative result means it fails.
Worked example over a 90-day window: a distributor starts with $180,000 in the bank and expects to collect $640,000 from customers over the next 90 days, giving available cash of $180,000 + $640,000 = $820,000. Payments contractually due in the same 90 days total $910,000, made up of $520,000 to suppliers, $250,000 of payroll and $140,000 of loan instalments and interest. The test result is $820,000 - $910,000 = -$90,000, a shortfall of $90,000, so the business fails the cash flow test unless it raises new funding, defers a payment or accelerates collections.Case study
Seen in the real world.
Harrowgate Kitchens is an illustrative, entirely fictional cabinet maker with revenue of $9m and a well regarded order book. On paper the company looked strong: assets of $6.4m against liabilities of $4.1m, so it passed the balance sheet test easily. The board reviewed profit monthly and rarely looked at a forward cash forecast.
In this illustrative scenario a new finance manager built a 13-week cash flow test and found that in week nine the company would have $410,000 available against $565,000 of committed payments, a shortfall of $155,000. The cause was structural rather than dramatic: customers were taking 68 days to pay while suppliers were being paid in 30, and a bank loan instalment happened to fall in the same week as quarterly tax.
The board responded by moving three large customers onto deposit terms and refinancing the loan onto monthly rather than quarterly instalments. Neither change improved profit by a single dollar, but both removed the shortfall, which is the practical lesson of the cash flow test: solvency problems are often timing problems in disguise.
Watch out
Common mistakes.
- Treating a profitable month as proof that the business passes the cash flow test, when profit is recorded on invoices raised rather than cash received.
- Counting the full invoiced value of receivables as available cash without adjusting for how slowly customers actually pay or for amounts in dispute.
- Including an overdraft or credit line as available cash when the facility is repayable on demand or due for renewal inside the test window.
Questions
People also ask.
What period should a cash flow test cover?
Thirteen weeks is the common working standard, though directors should also consider large debts falling due just beyond that window before concluding the company is solvent.
Is failing the cash flow test the same as being bankrupt?
No, it is a warning that the company cannot meet obligations on time, and it can often be cured by refinancing, new investment or renegotiated terms before any formal insolvency process begins.
Who actually runs this test in a normal company?
Usually the finance team as part of routine forecasting, but the responsibility sits with the directors, who are expected to know whether the business can pay its debts as they fall due.
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