Where the money actually went

Two statements already describe the business: one says what it earned over a period, the other says what it owns and owes at a moment. Neither of them tells you what happened to the money, and neither can be rearranged into that answer on its own. So there is a third document, and it is built as a reconciliation rather than as a report.

That construction is the point. The cash flow statement starts from a figure that is already published, applies a short list of adjustments, and has to land exactly on the change in the bank balance. If it does not land, something is wrong and the failure to land is how you find it.

Working capital is the money a business has tied up in trading rather than sitting in the bank. Three things make it up. Money customers owe and have not paid, which at Marchmont runs at 75 days of sales. Stock on the shelf that has been paid for and not yet sold, which runs at 60 days. And money the business owes its own suppliers and has not yet paid, which runs at 30 days and works in the opposite direction, because an unpaid bill is a free loan for as long as it lasts.

The level of working capital is not what appears on the cash flow statement. The change in it is. Holding £2m tied up costs nothing this month if it was £2m last month too. Going from £2m to £2.3m costs £300,000 of cash this month, and that is the line the statement shows.

Equipment is bought once and used for years. Charging the whole purchase to the month it arrived would make that month look ruinous and the following years look free, so the cost is spread across the working life of the machine. Marchmont spreads it over 60 months. That spreading is depreciation, and it is a real cost: the equipment is genuinely being used up.

What it is not is a payment. No money leaves the bank when a depreciation charge is booked, because the money left when the equipment was bought. So a walk that starts at profit has to put it back, and the money that actually went on equipment is subtracted separately, two lines further down, in the period it was really spent.

The working capital line is the one people skip, and it is the one that answers the question. Read it as a sentence with a destination: this much money stopped being cash and became invoices and stock. Marchmont's twelve months put £664,607 through that door. The money is not gone, it is not spent and it is not lost. It is in a warehouse and in other companies' accounts payable systems.

The direction is worth saying explicitly because the sign confuses everybody at first. Working capital going up is cash going down. A business that suddenly collects faster or holds less stock releases cash and the line turns positive, which is why a company in trouble can post an unusually good cash quarter while shrinking.

Two things on the cash flow statement are contested and neither has a settled answer. The first is classification: which section a given movement belongs in. Reasonable preparers disagree, different reporting frameworks answer differently, and the choice moves the headline operating cash flow figure without a single pound of bank activity changing. A reader who compares two companies on operating cash flow without checking what each put where is comparing two different measurements.

The second is the word "free". There is no single agreed definition of free cash flow. Some subtract all capital spending, some subtract only what is needed to stand still and treat the rest as growth investment, some subtract lease payments and some do not. Ask three analysts and you will get three subtraction lists, all defensible. The practical response is not to pick a winner but to refuse the phrase on its own: whenever a free cash flow figure appears, the useful question is what was subtracted to get there, and it is a fair question to ask of your own team as well as somebody else's.

Month 10 is the best month Marchmont has had. Net income £52,781, up from £14,062 in month 1, with no loss anywhere in the run. In that same month the cash balance is minus £7,432. The reason is one row to the left: £67,443 went into working capital that month, more than the profit earned, because the business shipped more than it collected.

Read across the row and the whole course is there in five numbers. Earning more is what put the cash balance under water, because at Marchmont every additional pound of sales arrives as a promise 75 days before it arrives as money.

This catches people out in the room every time. Free cash flow goes from minus £35,961 in month 2 to minus £18,901 in month 12, which is an improvement of seventeen thousand pounds a month. And yet the cash balance falls the whole way, from £224,102 to minus £47,261.

There is no contradiction. Free cash flow is a flow and cash is a level, which is the distinction from session 1 doing real work. Every month the flow is negative the level goes down, and a less negative flow still goes down, only more slowly. Marchmont's monthly bleeding is getting smaller and the bath is still emptying.

The bridge explains where money went. It does not say whether it should have gone there. £664,607 in invoices and stock is a fact about position, not a verdict on management: the same figure describes a business winning larger customers who demand longer terms and a business failing to collect from small ones.

Nor does it price the alternatives. Collecting in 45 days rather than 75 would change the cash picture completely and change the profit figure not at all, but it means renegotiating terms customers have already agreed to. Holding 30 days of stock instead of 60 releases cash and risks a stockout. The model can measure what each is worth in pounds and is silent on what each costs in goodwill and lost orders, and any lever quoted without that second half is being quoted incompletely. The measured levers are session 4 and the practitioner track.