Understanding Cash Flow and Cash Flow Statements

Cash flow refers to the movement of money and cash equivalents into and out of a business over a specific period. It encompasses all the cash inflows and outflows associated with a company's operations, investing, and financing activities.

Understanding cash flow is crucial for evaluating a business's financial health and gauging whether it has enough cash to meet its obligations. Public companies will release cash flow statements as one of three main financial statements, along with balance sheets and income statements.

Cash flow analysis helps determine how much cash a company generates and uses, thereby providing insight into its liquidity and operational efficiency.

Positive Cash Flow vs Negative Cash Flow

Positive cash flow occurs when a business generates more money than it spends during a specified period. This indicates a healthy financial state where the business has sufficient cash to cover its operating expenses, invest in growth opportunities, and fulfill its financial obligations. Positive cash flows enable a company to strengthen its shareholder value by paying dividends, reducing outstanding debt, and building a reserve for future uncertainties.

Negative cash flow, on the other hand, occurs when a company's cash outflow, like operating expenses and accounts payable, exceeds its cash inflows. Negative cash flow can signal potential liquidity issues and the inability to sustain normal business operations if the business does not secure external financing. Persistent negative cash flows can lead to serious financial distress, signaling red flags to potential and current investors.

How to Calculate Net Cash Flow

To calculate net cash flow, sum the cash inflows and subtract the cash outflows from operating, investing, and financing activities within a specific period. The formula is:

Net Cash Flow = Operating Cash Flow + Investing Cash Flow + Financing Cash Flow

Calculating cash flow can provide a comprehensive view of how much cash a business generates and consumers from various activities. Investors can calculate cash flow using figures from other financial statements if a recent cash flow statement is not available.

Net cash flow provides a comprehensive view of how much cash a business generates or consumes from its various activities, aiding in effective financial planning and decision-making.

What is a Cash Flow Statement?

A cash flow statement, also known as the statement of cash flows, is a financial statement that provides detailed information about a company's cash inflows and outflows over a specific period. A cash flow statement is divided into three main sections: operating activities, investing activities, and financing activities.

Unlike the income statement, which focuses on profitability, the cash flow statement emphasizes actual cash movements, making it essential for assessing liquidity and financial stability.

Types of Cash Flow

Because cash flow is used to describe any movement of money in or out of a business, there are many different ways to categorize cash flow on a balance sheet. Below is a breakdown of several common types of cash flow.

Free Cash Flow (FCF)

Free cash flow (FCF) represents the amount of money a business holds after paying typical business expenses, referred to as capital expenditures. Free cash flow on a company's balance sheet is one way to get a quick measurement of a company's financial performance.

Long-term free cash flow is an estimate of remaining free cash over the next one to five years. This remaining cash flow is often used to pay dividends, buy back stock, or pay off debt.

Operating Cash Flow (CFO)

Cash flow from operations (CFO) measures the cash generated or consumed by a company's core business activities. It indicates whether a business can generate sufficient cash from its operations to maintain and expand its activities without relying on external financing.

Operating cash flow is calculated by adjusting net income for changes in working capital and non-cash items like depreciation and amortization. Positive operating cash flow signifies strong operational performance, while negative operating cash flow can indicate potential liquidity problems.

Investing Cash Flow (CFI)

Cash flow from investments (CFI) reflects the cash used for and money generated from investments in long-term assets such as property, plant, and equipment (PP&E), as well as acquisitions and sales of investments.

A negative investing cash flow typically indicates that a company is investing in its future growth, which can be beneficial if these investments yield returns. Conversely, positive investing cash flow may suggest asset sales or reduced investment activities, which could impact future growth.

Financing Cash Flow (CFF)

Cash flow from finances (CFF) includes cash flows from transactions involving equity, debt, and dividend payments. This section covers activities like issuing or repurchasing stock, borrowing or repaying loans, and paying dividends.

A positive financing cash flow indicates that the business is raising capital, either through debt or equity, which can be used for expansion or other purposes. A negative financing cash flow might suggest that the company is paying down debt or distributing profits to shareholders, potentially signaling strong financial health.

Cash Flow Statement Example

Cash flow statements are usually released to shareholders once per year as one of three key financial statements published by public companies (the other two being income statements and balance sheets). Below is an example of a cash flow statement with sections on operations, investments, and finances. 

Cash Flow Statement Example
Operating activities
Net income	$270,000
Increase in accounts receivable	($30,000)
Increase in inventory	($20,000)
Net cash flow from operating activities	$220,000
Investing activities
Sale of a company vehicle	$10,000
Payment for acquisition of equipment	($50,000) *
Net cash flow from investing activities	($40,000)
Financing activities
Debt payments	($30,000)
Net cash flow from financing activities	($30,000)
Net cash flow	$150,000
Cash on hand at start of period	$70,000
Cash on hand at end of period	$220,000

Cash Flow Forecast

A cash flow forecast is a projection of a company’s future cash inflows and outflows over a specified period. It helps businesses anticipate cash shortages and plan accordingly. Accurate forecasting involves analyzing past cash flow patterns, upcoming expenses, expected revenues, and adjusting for any known changes. Regular updates to the cash flow forecast enable companies to make informed decisions about spending, investment, and financing, ensuring they maintain a healthy cash balance.

Cash Flow FAQs

What is the Difference Between Cash Flow and Revenue

Revenue represents the total income generated from sales of goods or services, reflecting the business's ability to generate sales. However, it does not account for the timing of cash receipts. In contrast, cash flow measures the actual cash inflows and outflows within a specified period. A company can have high revenue but face cash flow problems if it has significant accounts receivable. Thus, while revenue indicates business performance, cash flow shows liquidity.

What is the Difference Between Cash Flow and Profits?

Profit, or net income, is the amount remaining after all expenses, including non-cash items like depreciation, are subtracted from total revenue. It’s an accounting measure found on the income statement. Cash flow, however, represents the actual movement of cash. A business can be profitable on paper but still face cash flow issues if it has high non-cash expenses or delayed cash collections. Therefore, profit shows overall performance, whereas cash flow provides insight into financial health.

How do Cash Flow Problems Usually Start?

Cash flow problems often start with a mismatch between cash inflows and outflows. Common causes include extended credit terms to customers, slow-paying clients, high inventory levels, or rapid growth that outpaces cash generation. Unexpected expenses, poor financial planning, and economic downturns can exacerbate these issues. Early identification and management of cash flow problems are crucial to avoid severe financial distress.

What is Cash Flow Risk?

Cash flow risk refers to the uncertainty and potential variability in a company's cash inflows and outflows. This risk can stem from market fluctuations, changes in customer payment behaviors, interest rate volatility, and operational disruptions. Managing cash flow risk involves maintaining cash reserves, diversifying revenue streams, optimizing working capital, and using financial instruments like hedges. Understanding and mitigating cash flow risk is essential for ensuring the business can meet its obligations and sustain operations during adverse conditions.