What is Cash Flow?
Cash Flow, also known as Cash Flow, It is a financial indicator that shows the amount of money that enters and leaves a company during a given period. It serves to measure the liquidity of the company, that is, its ability to generate cash and meet its immediate obligations without the need to sell assets or resort to external financing.
Cash Flow is essential for the management of any business, as it allows you to plan liquidity needs, evaluate the ability to generate profits and assess financial risk.
Who discovered this concept?
The concept of “Cash Flow” or “Cash Flow” was not “discovered” by a single person, like many other ideas and concepts in the field of accounting and finance. In reality, it is the result of centuries of evolution and development in accounting theory and practice.
Cash Flow as a measure of financial performance and liquidity management developed over time as accountants and financiers sought ways to understand and measure the financial health of a company beyond simply net profits. By taking into account actual cash inflows and outflows, Cash Flow provides a more complete and accurate picture of a company's liquidity, its ability to pay debt, and its ability to generate value for shareholders.
In addition, the standardization of the use of the cash flow statement, where the Cash Flow is reflected, has been influenced by international organizations such as the Financial Accounting Standards Board (FASB) in the United States and the International Accounting Standards Board (IASB) at the level global.
What is the Cash Flow formula?
The general formula to calculate Cash Flow is:
Cash Flow = Cash Flow from Operations (CFO) + Cash Flow from Investment (CFI) + Cash Flow from Financing (CFF)
These terms represent the three main components of Cash Flow: cash flow from operations, cash flow from investments, and cash flow from financing.
Types of Cash Flow
- Operating Cash Flow (CFO): This is the cash flow generated by the company's operational activities, that is, those related to the production and sale of goods or services. To calculate it, net income is added and adjusted for changes in operating assets and liabilities, as well as depreciation and amortization.
- Investment Cash Flow (CFI): This is the cash flow resulting from the company's investments, such as the purchase or sale of fixed assets (machinery, buildings), financial investments or acquisitions of other companies. Generally, investments imply a negative cash flow (money outflow) since they represent an outflow of resources.
- Financing Cash Flow (CFF): This is the cash flow derived from financing activities, such as the issuance or repayment of debt, the issuance or repurchase of shares, or the payment of dividends. These activities can generate both inflows and outflows of money.
In addition to these, there is another type of Cash Flow called Free Cash Flow, which we talk about below.
Free Cash Flow (FCF)
Free Cash Flow (FCF) or Free Cash Flow It is a measure that indicates how much money a company generates after paying all its operating expenses and investments in working capital and fixed assets. It is a crucial indicator for investors as it represents the cash available to distribute to shareholders without affecting the growth of the company.
The general formula to calculate FCF is:
Free Cash Flow = Operating Cash Flow (CFO) – Capital Expenses (Capex)
Where:
CFO is the Cash Flow from the company's operations.
Capex is the investment in fixed assets.
Positive Cash Flow
A positive cash flow indicates that the company is generating more income than it is spending. This is the ideal scenario for any business, since it means that it has enough resources to cover its operating expenses, invest in its growth, repay debts, pay dividends to shareholders and have a safety cushion to face unforeseen events.
- Positive operating cash flow means that the company is generating sufficient revenue from its regular business operations. It is a good indication of the short-term financial health of the company and the effectiveness of its business model.
- A positive investing cash flow is less common, as companies typically invest in long-term assets (which would imply a negative investing cash flow). However, positive investment cash flow can occur when the company sells a large amount of these assets.
- A positive financing cash flow indicates that the company is receiving more money from investors or lenders than it is returning to them.
Negative Cash Flow
A negative cash flow, on the other hand, means that the company is spending more money than it is generating. This may be a cause for concern as it may indicate liquidity problems. However, it is not always a warning sign, it depends on the context.
- Negative operating cash flow may indicate that the company is not generating enough revenue from its business operations, which is a red flag. However, if you are a growing company that is investing heavily in acquiring new customers, it could be temporary and not necessarily indicative of long-term problems.
- Negative investing cash flow is common and is generally seen as a positive sign as it means the company is investing in long-term assets to grow and expand.
- A negative financing cash flow is not necessarily a bad thing. It can mean that the company is repaying debt or distributing dividends to shareholders, which can be viewed positively.
In summary, a positive or negative cash flow must be interpreted in the context of the company's operations, its growth phases, and its investment and financing strategy. Each component of cash flow (operating, investing, financing) has its own implications and must be analyzed together to have a complete view of the financial health of the company.
Cash Flow Exercises
Below we leave you a Cash Flow exercise. If you want to see more, check out our Economics exercises:
Example. Suppose a small business has the following financial information for the last quarter:
- Sales income: €15.000
- Cost of goods sold: €5.000
- Operating expenses (salaries, rent, services): €3.000
- Amortization: €500
- Investments in fixed assets (machinery, equipment): €2.000
- Issuance of new shares: €1.000
- Debt payment: €1.500
First, we calculate the Operating Cash Flow (CFO). To do this, we subtract the operating expenses and amortization from the net income:
Net Income = Sales income – Cost of goods sold = €15.000 – €5.000 = €10.000
CFO = Net Income – Operating Expenses – Amortization = €10.000 – €3.000 – €500 = €6.500
Next, we calculate the Cash Flow of Investment (CFI). In this case, investments are an outflow of money, so the CFI is negative:
CFI = – Investments in fixed assets = -€2.000
Finally, we calculate the Financing Cash Flow (CFF). We add the money obtained from the issuance of shares and subtract the payment of the debt:
CFF = Issuance of new shares – Debt payment = €1.000 – €1.500 = -€500
Now, to obtain the total Cash Flow, we add the CFO, the CFI and the CFF:
Total Cash Flow = CFO + CFI + CFF = €6.500 – €2.000 – €500 = €4.000
Therefore, the company's total cash flow during the last quarter is €4.000. This means that, after all operations, investments and financing, the company generated a surplus of €4.000.
Cash Flow game
If you want to play the Board game Created by Robert Kiyosaki (author of the Book Rich Dad Poor Dad), click here.
