Cash flow

Cash flow

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Encyclopedia
Cash flow is the movement of money
Cash
In common language cash refers to money in the physical form of currency, such as banknotes and coins.In bookkeeping and finance, cash refers to current assets comprising currency or currency equivalents that can be accessed immediately or near-immediately...

 into or out of a business, project, or financial product. It is usually measured during a specified, finite 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 e.g. be used for calculating parameters:
  • to determine a project's rate of return
    Rate of return
    In finance, rate of return , also known as return on investment , rate of profit or sometimes just return, is the ratio of money gained or lost on an investment relative to the amount of money invested. The amount of money gained or lost may be referred to as interest, profit/loss, gain/loss, or...

     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
    Internal rate of return
    The internal rate of return is a rate of return used in capital budgeting to measure and compare the profitability of investments. It is also called the discounted cash flow rate of return or the rate of return . In the context of savings and loans the IRR is also called the effective interest rate...

     and net present value
    Net present value
    In finance, the net present value or net present worth of a time series of cash flows, both incoming and outgoing, is defined as the sum of the present values of the individual cash flows of the same entity...

    .
  • to determine problems with a business's liquidity
    Accounting liquidity
    In accounting, liquidity is a measure of the ability of a debtor to pay his debts as and when they fall due. It is usually expressed as a ratio or a percentage of current liabilities.-Calculating 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 example, 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 is a generic term used differently depending on the context. It may be defined by users for their own purposes. It can refer to actual past flows or projected future flows. 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
Operating cash flow
In financial accounting, operating cash flow , cash flow provided by operations or cash flow from operating activities , refers to the amount of cash a company generates from the revenues it brings in, excluding costs associated with long-term investment on capital items or investment in securities...

 and free cash flow
Free cash flow
In corporate finance, free cash flow is cash flow available for distribution among all the securities holders of an organization. They include equity holders, debt holders, preferred stock holders, convertible security holders, and so on....

.

Statement of cash flow in a business's financials


The (total) net cash flow of a company over a period (typically a quarter 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
    Operating cash flow
    In financial accounting, operating cash flow , cash flow provided by operations or cash flow from operating activities , refers to the amount of cash a company generates from the revenues it brings in, excluding costs associated with long-term investment on capital items or investment in securities...

    : Cash received or expended as a result of the company's internal business activities. It includes cash earnings plus changes to working capital
    Working capital
    Working capital is a financial metric which represents operating liquidity available to a business, organization or other entity, including governmental entity. Along with fixed assets such as plant and equipment, working capital is considered a part of operating capital. Net working capital is...

    . Over the medium term this must be net positive if the company is to remain solvent.
  2. Investment cash flows
    Investment
    Investment has different meanings in finance and economics. Finance investment is putting money into something with the expectation of gain, that upon thorough analysis, has a high degree of security for the principal amount, as well as security of return, within an expected period of time...

    : Cash received from the sale of long-life assets, or spent on capital expenditure
    Capital (economics)
    In economics, capital, capital goods, or real capital refers to already-produced durable goods used in production of goods or services. The capital goods are not significantly consumed, though they may depreciate in the production process...

     (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.

Ways Companies Can Augment Reported Cash Flow


Common methods include:
  • Sales - Sell the receivables to a factor for instant cash. (leading)
  • Inventory - Don't pay your suppliers for an additional few weeks at period end. (lagging)
  • Sales Commissions - Management can form a separate (but unrelated) company and act as its agent. The book of business can then be purchased quarterly as an investment.
  • Wages - Remunerate with stock options.
  • Maintenance - Contract with the predecessor company that you prepay five years worth for them to continue doing the work
  • Equipment Leases - Buy it
  • Rent - Buy the property (sale and lease back, for example).
  • Oil Exploration costs - Replace reserves by buying another company's.
  • Research & Development - Wait for the product to be proven by a start-up lab; then buy the lab.
  • Consulting Fees - Pay in shares from treasury since usually to related parties
  • Interest - Issue convertible debt where the conversion rate changes with the unpaid interest.
  • Taxes - Buy shelf companies with TaxLossCarryForward's. Or gussy up the purchase by buying a lab or O&G explore co. with the same TLCF.

Examples

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.

See also

  • Cash flow sign convention
    Cash flow sign convention
    The cash flow sign convention is that money you pay out has a minus sign, while money you take in has a plus sign .* Most financial calculators follow the Cash Flow Sign Convention. This is simply a way of keeping the direction of the cash flow straight. Cash inflows are entered as positive...

  • Cash flow hedge
    Cash flow hedge
    A cash flow hedge is a hedge of the exposure to the variability of cash flow that# is attributable to a particular risk associated with a recognized asset or liability...

  • Cash flow projection
  • Cash flow statement
    Cash flow statement
    In financial accounting, a cash flow statement, also known as statement of cash flows or funds flow statement, is a financial statement that shows how changes in balance sheet accounts and income affect cash and cash equivalents, and breaks the analysis down to operating, investing, and financing...

  • Internal rate of return
    Internal rate of return
    The internal rate of return is a rate of return used in capital budgeting to measure and compare the profitability of investments. It is also called the discounted cash flow rate of return or the rate of return . In the context of savings and loans the IRR is also called the effective interest rate...

  • Net present value
    Net present value
    In finance, the net present value or net present worth of a time series of cash flows, both incoming and outgoing, is defined as the sum of the present values of the individual cash flows of the same entity...

  • Return of capital
    Return of capital
    Return of capital refers to payments back to "capital owners" that exceed the growth of a business. It should not be confused with return on capital which measures a 'rate of return'....


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