Cash flow is the net cash and cash equivalents transferred in and out of a company. Cash received represents inflows, while money spent represents outflows. A company’s ability to generate positive cash flows and maximize long-term free cash flow (FCF) is foundational to creating shareholder value. FCF represents the cash from regular business operations after accounting for capital expenditures (CapEx).
Key Takeaways
- Cash flow is the movement of money in and out of a company.
- Cash received signifies inflows, and cash spent signifies outflows.
- The cash flow statement is a financial statement that tracks a company’s sources and use of cash over time.
- The company’s cash flow can be categorized into cash flows from operations, investing, and financing.
Formula and Calculation of Cash Flow
You can easily calculate a company’s cash flow using the formula below. To do this, identify the total cash inflow and the total cash outflow:
CF = TCI - TCO
Where:
- TCI = Total cash inflow
- TCO = Total cash outflow
Understanding Cash Flow
Cash flow refers to the money that moves in and out of a business. Income from sales (revenue) constitutes inflows, while expenses are outflows. Assessing cash flows is crucial for evaluating a company’s liquidity, flexibility, and overall financial performance.
Positive cash flow reflects an increase in a company’s liquid assets, allowing it to cover its obligations, reinvest in the business, return money to shareholders, pay expenses, and buffer against future challenges. Particularly during economic downturns, companies with strong financial flexibility can better sidestep financial distress.
Cash Flow Statement
The cash flow statement acts as a corporate checkbook, reconciling a company’s balance sheet and income statement. It reports the net increase or decrease in cash and cash equivalents (CCE). This is reflected at the bottom of the cash flow statement where the overall change in the company’s cash and equivalents is recorded over the specified period.
Types of Cash Flow
Cash Flows From Operations (CFO)
Cash flows from operations (CFO), also known as operating cash flow, details the cash generated from ordinary business activities. It indicates whether or not a company has enough funds to cover its bills or operating expenses. CFO is an essential indicator on a cash flow statement showing whether a company can sustainably grow and manage its operations.
Cash Flows From Investing (CFI)
Cash flows from investing (CFI) or investing cash flow denotes the cash generated or spent on investment activities such as purchases of speculative assets, securities, or property. A negative CFI might signify hefty investments within the company, like in research and development, not necessarily indicating a warning sign.
Cash Flows From Financing (CFF)
Cash flows from financing (CFF) shows the net cash used to finance the company. Known as financing cash flow, CFF includes transactions like issuing debt or equity and paying dividends. Investors appreciate this measure as it provides insight into the company’s financial robustness and capital structure management.
How to Analyze Cash Flows
Using the cash flow statement alongside other financial statements allows analysts and investors to compute metrics and ratios vital for well-informed decision-making. Key analysis points include:
- Free Cash Flow (FCF): This measures financial performance, reflecting funds available to expand the business or return to shareholders after paying dividends, buying back stock, or paying off debt.
- Unlevered Free Cash Flow (UFCF): This shows available cash before financial obligations, excluding interest payments.
- Operating Cash Flow (OCF): Cash generated from a company’s primary operations.
- Cash Flow to Net Income Ratio: Indicates a firm’s cash generating efficiency against net income with an optimal goal of 1:1.
- Current Liability Coverage Ratio: Assesses the firm’s ability to cover current liabilities using cash flow from operations.
- Price to Cash Flow Ratio: Calculates operating cash flow per share compared to the stock price.
Inspiring Example of Cash Flow
Consider a hypothetical cash flow statement for a retail giant for the fiscal year ending on Dec. 31, 2023, showing all amounts in millions of USD. Investments in property, plant, and equipment (PP&E) and other businesses get recorded under investing activities. Similarly, proceeds from issuing long-term debt, debt repayments, and dividends are tracked under financing activities. The company’s cash flow showed a substantial positive amount, indicating increased reserves and robust long-term financial health.
How Are Cash Flows Different Than Revenues?
Revenue is income from selling goods and services while cash flows account for actual money transfers. Revenues booked as accounts receivable don’t reflect immediate cash inflows. Cash flows, on the other hand, also consider outflows and inflows, categorized by their purpose.
What is the Difference Between Cash Flow and Profit?
Cash flow and profit are not synonymous. Profit is the measure of how much money remains after all expenses—detailing a company’s financial success. Cash flow outlines all money transactions, indicating liquidity and operational efficiency.
What Is Free Cash Flow and Why Is It Important?
Free cash flow remains after covering operating expenses and CapEx. This residual income enables companies to pursue growth opportunities, pay dividends, and hedge against financial uncertainties.
Do Companies Need to Report a Cash Flow Statement?
Since 1987, all public companies must include cash flow statements in their financial reports, complementing the balance sheet and income statement.
Why Is the Price-to-Cash Flows Ratio Used?
The price-to-cash flow (P/CF) ratio evaluates a stock’s valuation by relating its price to operating cash flow per share. It’s especially beneficial for valuing stocks of companies with strong cash flow but unprofitable due to non-cash charges.
The Bottom Line
Cash flow is the flow of money in and out of the company. Positive cash flow signifies more money coming in, while negative cash flow indicates greater spending. A net cash flow calculation derives from subtracting total cash outflows from total cash inflows.
Related Terms: liquidity, revenue, profit, free cash flow, operating cash flow.
References
- U.S. Securities and Exchange Commission. “Beginners’ Guide to Financial Statements”.
- U.S. Securities and Exchange Commission. “Explanation of Non-GAAP and Other Financial Measures”.
- U.S. Securities and Exchange Commission. “Form 10-K”, Page 5.
- FASB. “Summary of Statement No. 95”.
