Cash flow

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For other uses, see Cash flow (disambiguation).

Cash flow is the movement of money into or out of a business, project, or financial product. It is usually measured during a specified, limited period of time. Measurement of cash flow can be used for calculating other parameters that give information on a company's value and situation. Cash flow can be used, for example, for calculating parameters: it discloses cash movements over the period.

  • to determine a project's rate of return or value. The time of cash flows into and out of projects are used as inputs in financial models such as internal rate of return and net present value.
  • to determine problems with a business's liquidity. Being profitable does not necessarily mean being liquid. A company can fail because of a shortage of cash even while profitable.
  • as an alternative measure of a business's profits when it is believed that accrual accounting concepts do not represent economic realities. For instance, a company may be notionally profitable but generating little operational cash (as may be the case for a company that barters its products rather than selling for cash). In such a case, the company may be deriving additional operating cash by issuing shares or raising additional debt finance.
  • cash flow can be used to evaluate the 'quality' of income generated by accrual accounting. When net income is composed of large non-cash items it is considered low quality.
  • to evaluate the risks within a financial product, e.g., matching cash requirements, evaluating default risk, re-investment requirements, etc.

Cash flow notion is based loosely on cash flow statement accounting standards. It's flexible as it can refer to time intervals spanning over past-future. It can refer to the total of all flows involved or a subset of those flows. Subset terms include net cash flow, operating cash flow and free cash flow.

Business' financials[edit]

The (total) net cash flow of a company over a period (typically a quarter, half year, or a full year) is equal to the change in cash balance over this period: positive if the cash balance increases (more cash becomes available), negative if the cash balance decreases. The total net cash flow is the sum of cash flows that are classified in three areas:

  1. Operational cash flows: Cash received or expended as a result of the company's internal business activities. It includes cash earnings plus changes to working capital. Over the medium term this must be net positive if the company is to remain solvent.
  2. Investment cash flows: Cash received from the sale of long-life assets, or spent on capital expenditure (investments, acquisitions and long-life assets).
  3. Financing cash flows: Cash received from the issue of debt and equity, or paid out as dividends, share repurchases or debt repayments. and

Examples[edit]

Description Amount ($) totals ($)
Cash flow from operations +10
  Sales (paid in cash) +30
  Materials -10
  Labor -10
Cash flow from financing +40
  Incoming loan +50
  Loan repayment -5
  Taxes -5
Cash flow from investments -10
  Purchased capital -10
Total +40

The net cash flow only provides a limited amount of information. Compare, for example, the cash flows over three years of two companies:

Company A Company B
Year 1 Year 2 year 3 Year 1 Year 2 year 3
Cash flow from operations +20M +21M +22M +10M +11M +12M
Cash flow from financing +5M +5M +5M +5M +5M +5M
Cash flow from investment -15M -15M -15M 0M 0M 0M
Net cash flow +10M +11M +12M +15M +16M +17M

Company B has a higher yearly cash flow. However, Company A is actually earning more cash by its core activities and has already spent 45M in long term investments, of which the revenues will only show up after three years.

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