- 1 What Is Cash Flow?
- 2 Understanding Cash Flow
- 3 Key Takeaways
- 4 Special Considerations
- 5 Types of Cash Flow
- 6 How to Analyze Cash Flows
- 7 How Are Cash Flows Different Than Revenues?
- 8 What Are the Three Categories of Cash Flows?
- 9 What Is Free Cash Flow and Why Is It Important?
- 10 Do Companies Need to Report a Cash Flow Statement?
- 11 Why Is the Price-to-Cash Flows Ratio Used?
What Is Cash Flow?
The term cash flow refers to the net amount of cash and cash equivalents being transferred in and out of a company. Cash received represents inflows, while money spent represents outflows. A company’s ability to create value for shareholders is fundamentally determined by its ability to generate positive cash flows or, more specifically, to maximize long-term free cash flow (FCF). FCF is the cash generated by a company from its normal business operations after subtracting any money spent on capital expenditures (CapEx).
Understanding Cash Flow
Cash flow is the amount of cash that comes in and goes out of a company. Businesses take in money from sales as revenues and spend money on expenses. They may also receive income from interest, investments, royalties, and licensing agreements and sell products on credit, expecting to actually receive the cash owed at a late date.
Assessing the amounts, timing, and uncertainty of cash flows, along with where they originate and where they go, is one of the most important objectives of financial reporting. It is essential for assessing a company’s liquidity, flexibility, and overall financial performance.
Positive cash flow indicates that a company's liquid assets are increasing, enabling it to cover obligations, reinvest in its business, return money to shareholders, pay expenses, and provide a buffer against future financial challenges. Companies with strong financial flexibility can take advantage of profitable investments. They also fare better in downturns, by avoiding the costs of financial distress.
Cash flows can be analyzed using the cash flow statement, a standard financial statement that reports on a company's sources and usage of cash over a specified time period. Corporate management, analysts, and investors are able to use it to determine how well a company can earn cash to pay its debts and manage its operating expenses. The cash flow statement is one of the most important financial statements issued by a company, along with the balance sheet and income statement.
- 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 reports on a company's sources and usage of cash over some time.
- A company's cash flow is typically categorized as cash flows from operations, investing, and financing.
- There are several methods used to analyze a company's cash flow, including the debt service coverage ratio, free cash flow, and unlevered cash flow.
As noted above, there are three critical parts of a company's financial statements:
- The balance sheet, which gives a one-time snapshot of a company's assets and liabilities
- The income statement, which indicates the business's profitability during a certain period
- The cash flow statement, which acts as a corporate checkbook that reconciles the other two statements. It records the company's cash transactions (the inflows and outflows) during the given period. It shows whether all of the revenues booked on the income statement have been collected.
Types of Cash Flow
Cash Flows From Operations (CFO)
Cash flow from operations (CFO), or operating cash flow, describes money flows involved directly with the production and sale of goods from ordinary operations. CFO indicates whether or not a company has enough funds coming in to pay its bills or operating expenses. In other words, there must be more operating cash inflows than cash outflows for a company to be financially viable in the long term.
Operating cash flow is calculated by taking cash received from sales and subtracting operating expenses that were paid in cash for the period. Operating cash flow is recorded on a company's cash flow statement, which is reported both on a quarterly and annual basis. Operating cash flow indicates whether a company can generate enough cash flow to maintain and expand operations, but it can also indicate when a company may need external financing for capital expansion.
Note that CFO is useful in segregating sales from cash received. If, for example, a company generated a large sale from a client, it would boost revenue and earnings. However, the additional revenue doesn't necessarily improve cash flow if there is difficulty collecting the payment from the customer.