Definition
Cash flow is the movement of money into or out of a business, project, or financial product . It is usually measured during a specified, finite period of time. Measurement of cash flow can be used for calculating other parameters that give information on a company's value and situation.
Cash
Cash flows reflect cash entering or leaving the organization.
Statement of Cash Flow in a Business's Financial Statements
A business's Statement of Cash Flows illustrates it's calculated net cash flow. The net cash flow of a company over a period (typically a quarter or a full year) is equal to the change in cash balance over this period: It's positive if the cash balance increases (more cash becomes available); it's negative if the cash balance decreases. The total net cash flow is composed of several factors:
- Operational cash flows: Cash received or expended as a result of the company's internal business activities. This includes cash earnings plus changes to working capital. Over the medium term, this must be net positive if the company is to remain solvent.
- Investment cash flows: Cash received from the sale of long-life assets or spent on capital expenditure, such as, investments, acquisitions, and long-life assets.
- Financing cash flows: Cash received from the issue of debt and equity, or paid out as dividends, share repurchases or debt repayments.
Uses
Cash flow factors can be used for calculating parameters, such as:
- to determine a project's rate of return or value. The cash flows into and out of projects are used as inputs in financial models, such as internal rate of return and net present value.
- to determine problems with a business's liquidity. Being profitable does not necessarily mean being liquid. A company can fail because of a shortage of cash even while profitable.
- as an alternative measure of a business's profits when it is believed that accrual accounting concepts do not represent economic realities. 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.
- can be used to evaluate the "quality" of income generated by accrual accounting. When net income is composed of large non-cash items, it is considered low quality.
- to evaluate the risks within a financial product (e.g., matching cash requirements, evaluating default risk, re-investment requirements, etc)
Cash flow is a generic term used differently depending on the context. It may be defined by users for their own purposes. It can refer to actual past flows or projected future flows. It can refer to the total of all flows involved or a subset of those flows.