Cash Flow

Updated on April 4, 2024
Article byWallstreetmojo Team
Edited byWallstreetmojo Team
Reviewed byDheeraj Vaidya, CFA, FRM

What is Cash Flow?

Cash flow refers to the inflow and outflow of cash and cash equivalents. Cash-flow is generated by business operations, investments, and financing. It determines a business’s cash position and cash availability.

Analyzing a company’s cash-flow provides critical information about its financial health, business activities, and reported earnings. Based on the analysis, future cash flows are projected. Consequently, financial analysts plan short-term goals, long-term goals, working capitalWorking CapitalWorking capital is the amount available to a company for day-to-day expenses. It's a measure of a company's liquidity, efficiency, and financial health, and it's calculated using a simple formula: "current assets (accounts receivables, cash, inventories of unfinished goods and raw materials) MINUS current liabilities (accounts payable, debt due in one year)"read more, and the optimum cash level required for business operationsBusiness OperationsBusiness operations refer to all those activities that the employees undertake within an organizational setup daily to produce goods and services for accomplishing the company's goals like profit generation.read more.

Key Takeaways

  • Cash flow is an inward and outward movement of cash and cash equivalents during a specific period.
  • The net money-flow is computed as:
    Net Cash Flow = Total Cash Inflows – Total Cash Outflows,
  • A cash flow statement summarizes the transactions for a specified period—cash generating activities and activities requiring cash expenditure.

Cash-Flow Explained

Cash Flow

You are free to use this image on your website, templates, etc, Please provide us with an attribution linkHow to Provide Attribution?Article Link to be Hyperlinked
For eg:
Source: Cash Flow (wallstreetmojo.com)

Cash flow indicates if a business has enough money for its operation. Any transaction that a company does in cash or cash equivalentCash EquivalentCash equivalents are highly liquid investments with a maturity period of three months or less that are available with no restrictions to be used for immediate need or use. These are short-term investments that are easy to sell in the public market..read more is penned down in a cash-flow statement to track the status of business funds and keep an account of the closing cash balance at the end of the accounting periodAccounting PeriodAccounting Period refers to the period in which all financial transactions are recorded and financial statements are prepared. This might be quarterly, semi-annually, or annually, depending on the period for which you want to create the financial statements to be presented to investors so that they can track and compare the company's overall performance.read more.

Cash comprises currency, coins, petty cashPetty CashPetty cash means the small amount that is allocated for the purpose of day to day operations. It is unreasonable to issue a check for such small expenses and for managing the same custodians are appointed by the company.read more, checking accountChecking AccountA checking account is a bank account that allows multiple deposits and withdrawals. Additionally, it provides superior liquidity.read more balance, savings account balance, money orders, and bank draftsBank DraftsA bank draft is a financial instrument purchased from a bank remitted later by a second party to withdraw the amount mentioned on the draft from any bank, guaranteeing that the draft holder shall receive the said amount on presenting the draft. It is also called a banker's cheque.read more. Cash equivalents refer to securities that can be liquidated within three months. It includes short-term government bondsGovernment BondsA government bond is an investment vehicle that allows investors to lend money to the government in return for a steady interest income.read more, marketable securitiesMarketable SecuritiesMarketable securities are liquid assets that can be converted into cash quickly and are classified as current assets on a company's balance sheet. Commercial Paper, Treasury notes, and other money market instruments are included in it.read more, treasury billsTreasury BillsTreasury Bills (T-Bills) are investment vehicles that allow investors to lend money to the government.read more, commercial papersCommercial PapersCommercial Paper is a money market instrument that is used to obtain short-term funding and is often issued by investment-grade banks and corporations in the form of a promissory note.read more, money market fundsMoney Market FundsA money market fund is a form of short-term debt security or open-ended mutual fund with a shorter maturity, offering good returns at high liquidity and low credit risk. The instruments it invests in include US Treasury bills, bank debt funds, and corporate commercial papers that could be taxable or free from tax.read more, and other short-term investments.

The net cash-flow can either be positive or negative. A positive cash flow reflects that the company has enough money to meet its future expensesExpensesAn expense is a cost incurred in completing any transaction by an organization, leading to either revenue generation creation of the asset, change in liability, or raising capital.read more. However, if the money is surplus, then the firm is not utilizing its liquid funds efficiently. On the contrary, a negative cash flow represents a company unable to pay off its liabilities.

Certain payments made by a company do not reflect in the profit and loss accountProfit And Loss AccountThe Profit & Loss account, also known as the Income statement, is a financial statement that summarizes an organization's revenue and costs incurred during the financial period and is indicative of the company's financial performance by showing whether the company made a profit or incurred losses during that period.read more statement, whereas the same is present in the cash flow statementCash Flow StatementA Statement of Cash Flow is an accounting document that tracks the incoming and outgoing cash and cash equivalents from a business.read more. For Example, if a company has a loan and is paying off the principal amount back to the bank, this transaction is not shown in the Profit and loss statement. But it will be mentioned in the cash flow statement. Sometimes, such companies show profits but do not have funds to pay off loans and obligations. Such situations can be identified using the cash flow statement.

Accounting for Financial Analyst (16+ Hours Video Series)

–>> p.s. – Want to take your financial analysis to the next level? Consider our “Accounting for Financial Analyst” course, featuring in-depth case studies of McDonald’s and Colgate, and over 16 hours of video tutorials. Sharpen your skills and gain valuable insights to make smarter investment decisions.

Types

A business entityBusiness EntityThe business entity concept declares that a business stands independently from its owner, and hence the two should be treated as separate entities when recording transactions. Therefore, all business transactions (income, expenses, assets, liabilities, and equity) must be kept separate from the owner’s account to ensure accurate accounting records.read more accrues profits via the following activities:

Types of Cash Flows

You are free to use this image on your website, templates, etc, Please provide us with an attribution linkHow to Provide Attribution?Article Link to be Hyperlinked
For eg:
Source: Cash Flow (wallstreetmojo.com)

#1 Cash-Flow from Operations

Operating activitiesOperating ActivitiesOperating activities generate the majority of the company's cash flows since they are directly linked to the company's core business activities such as sales, distribution, and production.read more include a company’s regular business operations. Inflows are generated by selling goods or rendering services, including the collection of sundry debtors. 

However, money outflows stream through various monetary payments like the purchase of inventory, releasing salaries, taxes, and miscellaneous operating expenses (OpEx)Operating Expenses (OpEx)Operating expense (OPEX) is the cost incurred in the normal course of business and does not include expenses directly related to product manufacturing or service delivery. Therefore, they are readily available in the income statement and help to determine the net profit.read more. It also includes the purchase and sale of trading securitiesTrading SecuritiesTrading securities are investments in the form of debt or equity that the company's management wants to actively purchase and sell to make a profit in the short term with securities they believe will increase in price. These securities can be found on the balance sheet at the fair value on the balance sheet date.read more.

#2 Cash-Flow from Investing

Investing activities refer to the funds contributed or acquired from purchasing or selling securities or investments. In such a case, money outflow results from the purchase of property, plant, equipment (PPE), and other investment instruments.

Money inflow is generated by selling the possessed securities. Such exchanges exclude securities held for dealing and trading activities.

#3 Cash-Flow from Financing

Financing activitiesFinancing ActivitiesThe various transactions that involve the movement of funds between the company and its investors, owners, or creditors in order to achieve long-term growth are referred to as financing activities. Such activities can be analyzed in the financial section of the company's cash flow statement.read more primarily include any receipts and payments related to capital. The inflow from financing refers to the raising of capital from equityEquityEquity refers to investor’s ownership of a company representing the amount they would receive after liquidating assets and paying off the liabilities and debts. It is the difference between the assets and liabilities shown on a company's balance sheet.read more or long-term debtsDebtsDebt is the practice of borrowing a tangible item, primarily money by an individual, business, or government, from another person, financial institution, or state.read more. It involves cash receipts from issuing common stockCommon StockCommon stocks are the number of shares of a company and are found in the balance sheet. It is calculated by subtracting retained earnings from total equity.read more, preferred stock, bonds, and various short-term and long-term borrowings. Thus, there are two significant sources of finance—shareholders and creditorsCreditorsA creditor refers to a party involving an individual, institution, or the government that extends credit or lends goods, property, services, or money to another party known as a debtor. The credit made through a legal contract guarantees repayment within a specified period as mutually agreed upon by both parties. read more.

In contrast, money outflow comprises repayment of borrowings, the redemption of bondsBondsBonds refer to the debt instruments issued by governments or corporations to acquire investors’ funds for a certain period.read more, treasury stockTreasury StockTreasury Stock is a stock repurchased by the issuance Company from its current shareholders that remains non-retired. Moreover, it is not considered while calculating the Company’s Earnings Per Share or dividends. read more repurchases, and payment of dividendsDividendsDividends refer to the portion of business earnings paid to the shareholders as gratitude for investing in the company’s equity.read more. However, indirect borrowing from accounts payableAccounts PayableAccounts payable is the amount due by a business to its suppliers or vendors for the purchase of products or services. It is categorized as current liabilities on the balance sheet and must be satisfied within an accounting period.read more is classified as cash flow from operating activities and not from financing activities.

Analysis

The analysis helps furnish vital information concerning the company’s business earnings and helps predict future cash flows. Following are some of the crucial ratios that help check major sources and uses of cash:

  1. Free CashFlow (FCF): It is the excess money left after paying capital expenditureCapital ExpenditureCapex or Capital Expenditure is the expense of the company's total purchases of assets during a given period determined by adding the net increase in factory, property, equipment, and depreciation expense during a fiscal year.read more. It defines the business efficacy of making money from the capital employedCapital EmployedCapital employed indicates the company's investment in the business, i.e., the total amount of funds used for expansion or acquisition and the entire value of assets engaged in business operations. "Capital Employed = Total Assets - Current Liabilities" or "Capital Employed = Non-Current Assets + Working Capital."read more.
  2. Operating CashFlow (OCF): It is money generated by a company’s primary business operation. A higher OCF signifies a good liquidity position of the company.
  3. Comprehensive Free Money-Flow Coverage: A percentage value is calculated by computing a fraction of FCF and net operating cash flow and multiplying it by 100. A positive percentage is better in this case as well.
  4. Current Liability Coverage Ratio: This ratio is computed as the fraction of cash-flow from operations and current liabilitiesCurrent LiabilitiesCurrent Liabilities are the payables which are likely to settled within twelve months of reporting. They're usually salaries payable, expense payable, short term loans etc.read more. It determines the company’s ability to pay off its current liabilities with the cash flow from operationsCash Flow From OperationsCash flow from Operations is the first of the three parts of the cash flow statement that shows the cash inflows and outflows from core operating business in an accounting year. Operating Activities includes cash received from Sales, cash expenses paid for direct costs as well as payment is done for funding working capital.read more. Therefore, a ratio below 1:1 is not acceptable.
  5. Price to Money-Flow Ratio: To determine this ratio, the operating cash flow per share is divided by the stock price. It thus ascertains a company’s worth from the shareholder’s perspective.
  6. Money-Flow Margin Ratio: It is a ratio of cash flow from operations and sales. It, therefore, equates to sales generated per dollar.
  7. Cash Flow to Net Income Ratio: It is the ratio of a firm’s net cash-flow and net incomeNet IncomeNet income for individuals and businesses refers to the amount of money left after subtracting direct and indirect expenses, taxes, and other deductions from their gross income. The income statement typically mentions it as the last line item, reflecting the profits made by an entity.read more. It represents the amount of cash and cash equivalentsCash And Cash EquivalentsCash and Cash Equivalents are assets that are short-term and highly liquid investments that can be readily converted into cash and have a low risk of price fluctuation.  Cash and paper money, US Treasury bills, undeposited receipts, and Money Market funds are its examples. They are normally found as a line item on the top of the balance sheet asset. read more consumed for providing a certain net income. A ratio of 1:1 is considered ideal.

Cash-Flow Formula

Net cash flowNet Cash FlowNet cash flow refers to the difference in cash inflows and outflows, generated or lost over the period, from all business activities combined. In simple terms, it is the net impact of the organization's cash inflow and cash outflow for a particular period, say monthly, quarterly, annually, as may be required.read more indicates the increase or decrease in the cash and cash equivalents within an accounting period. The formula is as follows:

Money Supply Formula 1

Or

Money Supply Formula 1-1

Example

Let us assume that XYZ Ltd. made the following money-flow statement for the year ending December 31, 2018:

Cash-Flow Example 1

Inter Ikea Group

Furniture giant IKEA’s cash flow for the financial year 2021 ending on August 31, 2021, is as follows:

Cash-Flow Example 1-1

Profit vs. Cash-Flow

The business’s profit or net income is the money earned by the company during a specific accounting period—as recorded in the book of accounts. It is the value acquired by deducting all the expenses from the revenueRevenueRevenue is the amount of money that a business can earn in its normal course of business by selling its goods and services. In the case of the federal government, it refers to the total amount of income generated from taxes, which remains unfiltered from any deductions.read more. On the contrary, cash-flow is the inward and outward movement of money from the business. It provides the closing cash balance of the firm after deducting all money outflows from money inflows.

Profits give an overview of the business performance in terms of sales; cash flowrepresents the efficiency of handling money. These two metrics don’t need to provide similar results. It can be possible for a company with a positive cash flow position to have low profitability. Similarly, a company with higher profits can generate a negative cash flow.

Moreover, the purposes of these two metrics are significantly different. On the one hand, profits are essential for attaining business goals. Money-flow on the other hand helps smooth operations without capital crunch in the short term—a measure of liquidity.

Frequently Asked Questions (FAQs)

How is cash flow calculated?

The formula used for computing the net cash flow of a company is as follows: Net MoneyFlow = Total Cash Inflows – Total Cash Outflows,
or,
Net MoneyFlow = CFO + CFI + CFF.

What is the purpose of the cash flow statement?

A cash flow statement mirrors the company’s efficiency in managing its cash and cash equivalents—pertaining to a particular accounting period. It represents the incoming and outgoing money from the business and the net cash balance at the end of the period.

How to manage cash flow?

Following are some of the best cash-flow management practices:
• Prepare a cash flow budget;
• Maintain cash reserves;
• Monitor money outflows;
• Reduce expenses.
• Increase sources of money inflows;
• Keep a check over excess inventory; and
• Streamline the process of cash flow.

This article has been a guide to what is cash flow and its meaning. Here we explain cash flows along with its formula, examples, calculations and its differences from Profit. You can learn more about financing from the following articles –