What is Cash Flow?
Cash flow refers to the change in the amount of funds owned by an institution, business, or person over a given period of time. In finance, cash flow refers to the amount that is either generated or consumed, representing the net balance of funds moving into and out of a business. A positive cash flow means that more funds are received than are sent out, and a negative means more is paid out than is received. Understanding cash flow is important for business operations, as it directly impacts a company's ability to pay bills, wages, and meet future objectives, making it one of the important metrics in finance and accounting. This article explains what is cashflow meaning, its types, and how to analyse the same.
How to Analyse Cash Flow?
Analysing cash flows is a process of systematically reviewing all business elements that influence and impact cash flows:
- Prepare Cash Flow Statements Regularly: The purpose of preparing cash flow statements on a regular basis is to have an idea about the present status of cash flow.
- Analyse Operating Activities: Study cash flows from operations, including earnings received, payments made to suppliers, and changes in working capital. The analysis helps understand how effectively the operations are self-sustaining in terms of cash flow.
- Evaluate Investing Activities: Examine cash flows associated with investment in fixed assets through the purchase or sale of existing assets. Compare business investment expenditures with business growth plans. Also, determine if investments are yielding anticipated returns.
- Analyse Financing Activities: Analyse the components of cash flow from the issuance of debt, equity, dividend payments, and debt repayment. Find out if the firm has a proper capital structure and if they are effectively managing their costs of finances.
- Ratio Calculation: Ratios such as cash conversion cycle ratio, day sales outstanding ratio, day sales payable ratio, and cash flow per share also need to be computed.
- Develop Cash Flow Projections: These should be based on possible future growth patterns, seasonality, future rises in rental and materials costs, and possible changes in market conditions. Project forward for at least three months to detect areas of shortfall.
- Monitor Working Capital: Monitor the changes in receivables, inventories, and payables. Proper management of working capital helps ensure that cash converts quickly through the business cycle, eliminating the need to hold large amounts of cash.
- Compare Cash Flow to Income: Analyse differences between reported net income and actual cash flow. Significant variances indicate timing differences, non-cash expenses, or working capital changes requiring management attention.
- Identify Cash Flow Patterns: Recognise seasonal variations, cyclical trends, and unusual fluctuations. Understanding patterns helps anticipate future needs and plan accordingly to maintain adequate cash reserves.
- Separate Essential from Growth Expenses: Distinguish expenses required for daily operations from those supporting growth ambitions. This provides an understanding of which cash flows are essential and which can be reduced during restricted periods.
Table of Content
- How to Analyse Cash Flow?
- Uses of Cash Flow
- Types of Cash Flow
- Difference Between Cash Flow, Income and Revenue
- Conclusion
Uses of Cash Flow
Cash flow serves numerous purposes in operating businesses and performing financial analysis. Understanding these uses helps businesses maintain financial health and make informed strategic decisions. The following table covers the uses of cash flow:
| Use | Description |
| Net Present Value (NPV) | Calculating business value by building a discounted cash flow (DCF) model and determining the net present value for investment evaluation. |
| Internal Rate of Return (IRR) | Determining the IRR an investor achieves for making an investment, helps assess investment profitability and compare different opportunities. |
| Cash Flow Per Share (CFPS) | Cash from operating activities is divided by the number of shares outstanding, providing per-share cash generation metrics for investors. |
| Dividend Payments | Cash flow can fund dividend payments to investors, providing returns to shareholders whilst maintaining business operations. |
| Capital Expenditures | Cash flow funds reinvestment and growth in the business through purchases of property, equipment, and other long-term assets necessary for expansion. |
| Liquidity Assessment | Evaluating a company's ability to meet short-term obligations and maintain operations without facing cash shortfalls or requiring emergency financing. |
Types of Cash Flow
Cash flow can be categorised into several types, each serving different purposes in financial analysis:
- Cash from Operating Activities: The cash generated or used for funding business activities, and does not include the cash generated from investments. It is the first component of the cash flow statement and represents net cash generated from revenue after deducting interest and taxes.
- Cash from Investing Activities: It encompasses long-term assets purchases and sales, like buying and selling property and equipment, investment in securities of other companies, loans to other entities, and mergers and acquisitions.
- Cash from Financing Activities: It is the net cash flow that is used in financing activities of a business and is used for investment in working capital. It includes activities involving the issuance of debt securities and equity securities, dividends paid, and capital leasing, which could be useful in determining how the firm is structured in terms of finances.
- Free Cash Flow (FCF): This refers to the operating cash flow of the company reduced by the capital expenditure or the amount of cash left or "free" for discretionary spending.
- Free Cash Flow to Equity (FCFE): Also known as "levered free cash flow". It shows cash generated after taking into account investments and debt payments. The calculation includes operating cash flow figures with deductions of capital expenditure and additions of net debt financing.
- Free Cash Flow to the Firm (FCFF): This is also known as "Unlevered Free Cash Flow". It is a hypothetical value which takes a company to be debt-free while using it in financial modelling to estimate enterprise value.
- Net Change in Cash: The change in cash flow amount from one accounting period to the next, found at the bottom of the Cash Flow Statement, shows overall cash position changes.
Difference Between Cash Flow, Income and Revenue
The following table highlights the difference between cash flow, income and revenue:
Aspect | Cash Flow | Income | Revenue |
| Definition | Net amount of cash moving into and out of the business over a period | Income is calculated using accrual accounting after deducting expenses from revenue | The total amount of funds a business earns from sales of goods or services before any expenses are deducted |
| Accounting Basis | Measures actual cash movements regardless of when transactions are recorded | Based on accrual accounting principles | Recognised when products or services are delivered according to accounting standards |
| Timing of Recognition | Records amounts only when cash actually changes hands | Revenue recognition policies and the matching principle determine timing | Recognised when products or services are delivered, regardless of when payment is received |
| Scope | Encompasses all cash movements: operating activities, investing activities, and financing activities | Appears on the income statement after expenses are deducted from revenue | Appears as the top line of the income statement, representing gross earnings |
| Non-Cash Items | Not affected by non-cash expenses like depreciation, amortisation, and stock-based compensation | Includes non-cash expenses like depreciation, amortisation, and stock-based compensation that reduce reported profit | Does not account for any costs or expenses |
| Working Capital Impact | Affected by changes in working capital balances (accounts receivable, inventory, accounts payable) | Not necessarily affected by working capital changes in the same period | Not directly affected by working capital |
| What It Measures | Liquidity - actual funds available | Profitability – economic performance on an accrual basis | Gross earnings - total sales amount |
| Business Health Indicator | Represents economic value and actual funds available that investors ultimately seek | May not reflect the true financial position | High revenue does not guarantee sufficient cash flow or business viability |
| Expense Consideration | Reflects net result after all cash inflows and outflows, including expenses, investments, and financing activities | Expenses are deducted to calculate net income | Does not account for any costs or expenses incurred to generate sales |
| Possible Scenarios | Can be positive with no profit, or negative despite positive income | Can be positive despite negative cash flow | Can be high while cash flow remains poor due to payment terms |
Disclaimer: All investments are subject to market risks, economic conditions, regulatory changes, and other external factors. Returns are not guaranteed and may vary based on market performance and investment tenure. Investors should assess their risk tolerance and financial objectives, conduct their own research, and consult a qualified financial advisor before making any investment decisions.
Conclusion
Cash flow shows how funds move through a business during a specific period. It helps organisations understand whether daily activities support regular payments and future plans. By reviewing operating, investing, and financing flows, one can understand the stability and liquidity of the business. Careful cash flow analysis also highlights spending patterns, funding needs, and efficiency gaps. Additionally, regular monitoring supports informed planning and disciplined control of business resources. Portfolio statements, transaction histories, and performance reports are also provided by online trading apps, which facilitate informed investment and capital planning decisions.
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