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.
- 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.
Symptoms of cash flow
problems. There are many reasons a business can
suffer cash flow problems – some are down to mismanagement and poor decisions,
and in some cases factors outside of your control. Any of the following
symptoms can indicate that a business is experiencing cash flow problems:
- Up to overdraft limit – no headroom
/ returned payments
- Stretch to pay salaries each month
- Trade creditor arrears
- Taxation arrears
- Rent arrears
- No working capital ‘buffer’ –
surviving day to day
- Negative working capital on
balance sheet – over geared / losses?
- Lack of funds for remedial action
(redundancies / premises relocation)
- Lack of profitability –
insufficient to support owner / manager’s lifestyle
- Unable to pay for professional
advice
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:
- 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.
- Investment cash flows: Cash
received from the sale of long-life assets, or spent on capital
expenditure (investments, acquisitions and long-life assets).
- Financing cash flows: Cash
received from the issue of debt and equity, or paid out as dividends,
share repurchases or debt repayments.
|
Description
|
Amount
($)
|
totals
($)
|
|
Cash flow from operations
|
+10
|
|
|
Sales (paid in cash)
|
-30
|
|
|
Incoming loan
|
+50
|
|
|
Loan repayment
|
-5
|
|
|
Taxes
|
-5
|
|
|
Cash flow from investments
|
-10
|
|
|
Purchased capital
|
-10
|
|
|
Total
|
+ 0
|
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
|
+9M
|
+10M
|
+11M
|
+13M
|
+14M
|
+15M
|
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.
