Cash Flow

Business, Legal & Accounting Glossary

Definition: Cash Flow


Quick Summary of Cash Flow


Revenue or expense streams that change a cash account over a given period. Cash inflows arise from one of three activities: financing, operations and investing. Cash flow can also be negative, if a business spends more money than it takes in during a given period of time.



What is the dictionary definition of Cash Flow?

Dictionary Definition


In finance, cash flow refers to the amounts of cash being received and spent by a business during a defined period of time, usually tied to a specific project. In accounting, a cash flow projection sets out all the expected payments and receipts in a given period. Managers use cash-flow projections to arrange for employees and creditors to be paid at appropriate times.

Cash flow is a company’s net inflow or outflow of cash. A cash flow statement (formally known as the statement of cash flows) shows a company’s cash flow from its operating, financing, and investing activities during an accounting period, and it is now required under Generally Accepted Accounting Principles. More informally, cash flow often means cash flow from operations, which is computed as net income plus noncash charges, especially depreciation. Indeed, a quick definition of cash flow is net income plus depreciation. Analysts often emphasize cash flow, as opposed to net income, because cash is the most liquid and tangible asset, while net income necessarily includes charges and credits that do not affect the company’s bank account. Many analysts refine the concept of cash flow to mean “free cash flow,” the amount of cash available to the company after funding capital projects. In its simplest definition, free cash flow is net income plus depreciation less capital expenditures.


Full Definition of Cash Flow


The amount of money which flows in and out of a business, the difference between the two is the important number. If more money flows into a business than out of it, it is cash positive. If more money flows out than in, it is cash negative.

Cash flow is a term that refers to the amount of cash being received and spent by a business during a defined period of time, sometimes tied to a specific project. Measurement of cash flow can be used

  • to evaluate the state or performance of a business or project.
  • to determine problems with liquidity. Being profitable does not necessarily mean being liquid. A company can fail because of a shortage of cash, even while profitable.
  • to generate project rate of returns. The time of cash flows into and out of projects are used as inputs to financial models such as internal rate of return, and net present value.
  • to examine the income or growth of a business when it is believed that accrual accounting concepts do not represent economic realities. Alternately, cash flow can be used to ‘validate’ the net income generated by accrual accounting.

Cash flow as a generic term may be used differently depending on the context, and certain cash flow definitions may be adapted by analysts and users for their own uses. Common terms (with relatively standardized definitions) include operating cash flow and free cash flow.

Cash flow is regarded by many as the ultimate test of financial health. Seasoned analysts do not entirely trust the figure a company puts on its profits, since profits can be ‘massaged’, whereas cash is more difficult to manipulate. Profit, as they say, is a matter of opinion. Cash is a matter of fact.

The best way to check the cash flow position of a company is to scrutinise the cash flow statement in its annual report and accounts. It provides fact on whether a company has generated or consumed cash in the year, and how. It can be used in conjunction with the p&l; to assess the trading results, or it can be used in conjunction with the balance sheet to assess liquidity, solvency and financial flexibility.

Classification

Cash flows can be classified into:

  1. Operational cash flows: Cash received or expended as a result of the company’s core business activities.
  2. Investment cash flows: Cash received or expended through capital expenditure, investments or acquisitions.
  3. Financing cash flows: Cash received or expended as a result of financial activities, such as receiving or paying loans, issuing or repurchasing stock, and paying dividends.

All three together are necessary to reconcile the beginning cash balance to the ending cash balance.

Benefits From Using Cashflow

The cash flow statement is one of the four main financial statements of a company. The cash flow statement can be examined to determine the short-term sustainability of a company. If cash is increasing (and operational cash flow is positive), then a company will often be deemed to be healthy in the short-term. Increasing or stable cash balances suggest that a company is able to meet its cash needs, and remain solvent. This information cannot always be seen in the income statement or the balance sheet of a company. For instance, a company may be generating profit, but still have difficulty in remaining solvent.

The cash flow statement breaks the sources of cash generation into three sections: operational cash flows, investing and financing. This breakdown allows the user of financial statements to determine where the company is deriving its cash for operations. For example, a company may be notionally profitable but generating little operational cash (as may be the case for a company that barters its products rather than selling for cash). In such a case, the company may be deriving additional operating cash by issuing shares, or raising additional debt finance.

Companies that have announced significant writedowns of assets, particularly goodwill, may have substantially higher cash flows than the announced earnings would indicate. For example, telecoms firms that paid substantial sums for 3G licenses or for acquisitions have subsequently had to write-off goodwill, that is, indicate that these investments were now worth much less. These write-downs have frequently resulted in large announced annual losses, such as Vodafone’s announcement in May 2006 that it had lost £21.9 billion due to a writedown of its German acquisition, Mannesmann, one of the largest annual losses in European history. Despite this large “loss”, which represented a sunk cost, Vodafone’s operating cash flows were solid: “Strong cash flow is one of the most attractive aspects of the cellphone business, allowing operators like Vodafone to return money to shareholders even as they rack up huge paper losses.”

In certain cases, cash flow statements may allow careful analysts to detect problems that would not be evident from the other financial statements alone. For example, WorldCom committed an accounting fraud that was discovered in 2002; the fraud consisted primarily of treating ongoing expenses as capital investments, thereby fraudulently boosting net income. Use of one measure of cash flow (free cash flow) would potentially have detected that there was no change in overall cash flow (including capital investments).

Dangers Of Isolating Operating Cash Flow

When analysts and the media refer to ‘cash flow’, they are most likely referring to “Operating Cash Flow”. This is only one of the three types of cash flows. There are adherent problems in isolating only this type of flows, because business can easily manipulate the classification.

Common methods of distorting the results include:

  • Sales – Sell the receivables to a factor for instant cash. (leading)
  • Inventory – Don’t pay your suppliers for an additional few weeks at period end. (lagging)
  • Sales Commissions – Management can form a separate (but unrelated) company act as its agent. The book of business can then be purchased quarterly as an investment.
  • Wages – Remunerate with stock options.
  • Maintenance – Contract with the predecessor company that you prepay five years worth for them to continue doing the work
  • Equipment Leases – Buy it
  • Rent – Buy the property (sale and leaseback, for example).
  • Oil Exploration costs – Replace reserves by buying another company’s.
  • Research & Development – Wait for the product to be proven by a start-up lab; then buy the lab.
  • Consulting Fees – Pay in shares from treasury since usually to related parties
  • Interest – Issue convertible debt where the conversion rate changes with the unpaid interest.
  • Taxes – Buy shelf companies with TaxLossCarryForward’s. Or gussy up the purchase by buying a lab or O&G explore co. with the same TLCF.

Examples of Cash Flow in a sentence


A properly structured life insurance policy is a safe investment tool and can be utilized by people to build up their wealth and plan for future cash flow
Once you own several properties, you can sell some of them for capital gains and keep some as rentals for a steady cash flow.


Cite Term


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Cash Flow. PayrollHeaven.com. Payroll & Accounting Heaven Ltd. https://payrollheaven.com/define/cash-flow/ (accessed: December 01, 2020).
American Psychological Association (APA):
Cash Flow. PayrollHeaven.com. Retrieved December 01, 2020, from PayrollHeaven.com website: https://payrollheaven.com/define/cash-flow/

Definition Sources


Definitions for Cash Flow are sourced/syndicated and enhanced from:

  • A Dictionary of Economics (Oxford Quick Reference)
  • Oxford Dictionary Of Accounting
  • Oxford Dictionary Of Business & Management

This glossary post was last updated: 26th April, 2020 | 59 Views.