Business, Legal & Accounting Glossary
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.
Cash flow is a catch-all term for the movement of cash through a company. It can be used in several different contexts.
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.
The amount of money that 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
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.
Cash flows can be classified into:
All three together are necessary to reconcile the beginning cash balance to the ending cash balance.
In investing and accounting, the phrase “cash flow” is paired with other words to mean certain things. Here are several:
One of four financial statements showing the movement of cash into and out of the company for a period of time. Here, the analyst or investor can reconcile net income, a GAAP number, to actual cash in the bank.
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. The 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).
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 businesses can easily manipulate the classification.
Common methods of distorting the results include:
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.
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This glossary post was last updated: 4th August, 2021 | 115 Views.