What Is Cash Flow

Cash flow (CF) is one of the most important concepts of modern financial analysis, financial planning, and financial management. It reflects all cash receipts and their expenditures that occurred in the past.

The numerical value of CF characterizes the value of the inflow of money if it is greater than zero, or the outflow of money if it is less than zero. Positive CR is generated by the funds received by the economic entity based on the results for the corresponding period. It can be, for example, sales revenues, the performance of work, and the provision of services. Negative CF is formed by the funds spent by the economic entity in the corresponding period, such as investments, loan repayment, costs of raw materials, energy, etc.

Cash Flow Definition

It is a sequence of money received or paid, distributed over time. For example, money is converted into stocks, receivables, and back into money, closing the cycle of the company's working capital movement. When CF decreases or completely shuts off, insolvency occurs. An enterprise may feel a lack of funds even if it formally remains profitable (for example, deadlines for payments by customers of the company are violated). That’s why profitable but illiquid companies can be on the verge of bankruptcy.

At Monfex.com, you can find around 100 definitions of financial terms, in addition to the cash flow definition.

Cash Flow Meaning

In essence, СF is the difference between the income and expenses of a business entity (usually a company), expressed as the difference between payments received and made. In general, this is the sum of the retained earnings of the company and its depreciation deductions, saved for the formation of its source of funds for the future renewal of fixed capital. In other words, сash flow is the net amount of money actually received by the company in a given period. It characterizes the degree of self-financing of the enterprise as well as its financial strength.

Cash Flow Analysis

CF analysis is a determination of the moments and amounts of cash inflows and outflows. The purpose of the CF analysis is to evaluate the financial stability and profitability of the enterprise. It starts with the calculation of CFs from current activities.

The financial well-being of an enterprise largely depends on the inflow of funds to cover its obligations. The lack of a minimum cash reserve may indicate financial difficulties. Excess cash may be a sign that the company incurs losses.

Cash Flow Statement

It is convenient to analyze CFs by using the cash flow statement. According to the international standard IAS7, this report is generated not by the sources and directions of the use of funds, but by the enterprise activity areas - current, investment, and financial. This statement is the main source of information for CF analysis.

The components of the CF statement are the cash inflow and outflow in the context of the current, investment, and financial activities of the organization.

Current activities include the impact of business operations that affect company profit. This category includes:

• sales of goods or services,
• acquisition of goods or services for the organization’s production activities,
• loan interest payments,
• salary payments,
• taxes.

Investment activities refer to the acquisition and sales of fixed assets, securities, loans, etc.

Financial activities include receiving and returning funds for company activities, operations on repurchased shares, etc.

The CF statement shows how profitable the organization was for the activity in the analyzed period. However, it cannot show the cash inflow and outflow in the current, investment, and financial activities of the company. The statement is prepared on an accrual basis when the income and expenses are recognized in the period of their occurrence.

To identify cash flows, it is necessary to transform the statement. In this case, adjustments are used, according to which incomes are recognized only in the amount of actually received cash, and expenses - in the number of actual payments.

There are two methods for transforming the CF statement: direct and indirect. With the direct method, each article of the statement is transformed. During this process, the actual CF and the actual expenses are determined. With the indirect method, it is not intended that each article of the income statement is transformed. According to this method, the calculation starts with the amount of annual profit or loss for the analyzed reporting period. This amount is adjusted by adding all expenses and subtracting all incomes that are not related to CF.

Before compiling a CF statement, it is necessary to find out which balance sheet item has been the source of cash flow formation for at least two periods. First, the change in each balance sheet item is calculated, after which this change is attributed either to the sources or consumption of funds according to the following rules:

• The source of available funds is any increase in the article referred to as “Obligations” or “Equity”, such as bank loans.
• Any decrease in active accounts is also a source of CF generation, for example, the sale of fixed assets or reduction of stocks.
• The consumption of cash funds represents any decrease in the account attributed to “Obligations” or “Equity”, such as the repayment of a loan.
• Any increase in active balance sheet items, such as the acquisition of fixed assets or formation of stocks.

Except for the cash flow definition, you can find other helpful terms in the financial dictionary at Monfex.com.

Types of Cash Flow

The primary value used for the analysis is Net Cash Flow. It represents the difference between all positive and all negative flows of the company. This indicator allows you to determine the amount of free cash at the disposal of the company. However, in addition to it, there are several ways of calculating the values ​​associated with the company’s CF.

Free Cash Flow to the Firm (FCFF) is another important indicator in the company's financial statement. In the classical sense, this indicator shows the volume of all cash received by the company, minus the costs of expanding or maintaining its asset base, determined by the Capex indicator. Its value serves to analyze the ability of an enterprise to settle its current obligations without using the funds involved in fixed assets.

Summary

Now you know what is cash flow and understand the importance of the CF analysis. In addition to the cash flow meaning, the Monfex.com glossary contains other financial terms that you’re looking for. Check out our financial dictionary today, we’d be happy to help.