Cash flow

Cash Flow Definition

Cash Flow (or cashflow) is the total amount of money moving into and out of a business or organization, representing the operating activities of a company. Cash flow is used to assess the quality of a company’s income — also referred to as a company’s liquidity — and if a company is positioned to be solvent.

In accounting, cash flow is the difference in amount of cash or cash-equivalents available at the beginning of the period (opening balance), and the amount of cash or cash-equivalents at the end of that period (closing balance). Positive cash flow is when the closing balance is higher than the opening balance at the end of the determined period — or when more cash is flowing into the business than out. Positive cash flow indicates increasing company assets, meaning that a business can settle its debts, pay expenses, fund growth, return money to shareholders, and protect against future financial challenges. Negative cash flow is when the closing balance is lower than the opening balance at the end of the determined period — or when more cash is flowing out of the business than in. Negative cash flow indicates decreasing company assets, and potential financial turmoil due to inability to pay debts, expenses, and other business operation costs.

The level of cash flow is not always the best measure of business performance because high levels of cash do not equate to profit, and vice versa, positive cash flow does not automatically translate to profitability. Cash flow can be increased by doing the following:

  • Selling more goods or services
  • Increasing the selling prices of the goods or services
  • Selling company assets
  • Reducing operational costs
  • Collecting payments faster
  • Paying debts and expenses slower
  • Bringing in more shareholder equity
  • Taking a loan

Free cash flow is a company’s operating cash flow minus capital expenditures. This is money that can be used to pay dividends, buy back stock, pay off debt, and expand the business.

A cash flow statement (or cash flow statement or statement of cash flows) is an essential financial report that can help determine a company’s sustainability or risk of insolvency. Cash flow determines the quality of a company’s income, so it is concerning if net cash flow is less than net income. If a company’s profits are tied up in accounts receivable, prepaid expenses, and inventory, it may not be liquid enough to survive a short-term business downturn.

A cash flow statement complements a balance sheet and income statement by recording the amount of cash and cash-equivalents going into and out of a company. There are three types of cash flow statements:

  • Operating cash flow: a company’s day-to-day operational costs
  • Investing cash flow: investments in business through acquisition, long-term assets, and securities
  • Financing cash flow: relates to a company’s investors and creditors; dividends paid to stockholders and cash proceeds from issuing bonds would be recorded here

Best Practices

Cash flow management is vital to a healthy business or organization. Many businesses make the mistake of focusing solely on sales and profits, while not keeping up with the amount of cash on hand to cover shortfalls, growth, and other sustainable business needs. Good cash flow management depends on these three principles:

  • Knowing what customers owe you and getting payment ASAP
  • Knowing what the business owes other and paying those expenses on time, avoiding unnecessary penalties
  • Identifying shortfalls and issues, and taking steps to fix them as soon as it is feasible

In addition, businesses can benefit from following some cash flow management best practices, including:

  • Monitoring your cash flow closely and regularly; have quick and easy access to the metrics you need to measure
  • Make projections monthly (instead of quarterly or yearly)
  • Prepare an accurate cash flow forecast that relies on historical data and trends, including customer payment histories and industry norms
  • Know you net cash position, which is your cash on hand at the start of a period + estimated cash in – estimated cash out
  • Invoice quickly to keep a steady stream of incoming cash
  • Have cash reserves for emergencies and a backup plan
  • Grow carefully, including hiring of human talent

Datapoints

Source: Will My Business Survive?

Cash Flow Transactions within Business Contemporary Engineering Economics, 5th edition. ©2010 Shareholders Fixed Assets De...

Source: Cash Flow Statement (Contemporary Engineering Economics)

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