cash flow



A cash flow is a real or virtual movement of
money Money is any item or verifiable record that is generally accepted as payment for goods and services and repayment of debts, such as taxes, in a particular country or socio-economic context. The primary functions which distinguish money are as ...
: *a cash flow in its narrow sense is a payment (in a currency), especially from one central bank account to another; the term 'cash flow' is mostly used to describe payments that are expected to happen in the future, are thus uncertain and therefore need to be forecast with cash flows; *a cash flow is determined by its time ''t'', nominal amount ''N'', currency ''CCY'' and account ''A''; symbolically ''CF'' = ''CF''(''t,N,CCY,A''). * it is however popular to use ''cash flow'' in a less specified sense describing (symbolic) payments into or out of a business, project, or financial product. Cash flows are narrowly interconnected with the concepts of value, ''interest rate'' and liquidity. A cash flow that shall happen on a future day ''t''N can be transformed into a cash flow of the same value in ''t''0.

Cash flow analysis

Cash flows are often transformed into measures that give information e.g. on a company's value and situation: *to determine a project's
rate of return In finance, return is a Profit (accounting), profit on an investment. It comprises any change in value of the investment, and/or cash flows (or securities, or other investments) which the investor receives from that investment, such as interest pa ...
or value. The time of cash flows into and out of projects are used as inputs in financial models such as
internal rate of return Internal rate of return (IRR) is a method of calculating an investment’s rate of return. The term ''internal'' refers to the fact that the calculation excludes external factors, such as the risk-free rate, inflation, the cost of capital, or fin ...
net present value The net present value (NPV) or net present worth (NPW) applies to a series of cash flows occurring at different times. The present value of a cash flow depends on the interval of time between now and the cash flow. It also depends on the discount ...
. *to determine problems with a business's
liquidity Liquidity is a concept in economics involving the convertibility of assets and obligations. It can include: * Market liquidity, the ease with which an asset can be sold * Accounting liquidity, the ability to meet cash obligations when due * Liqui ...
. 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
profit Profit may refer to: Business and law * Profit (accounting) Profit, in accounting, is an income distributed to the ownership , owner in a Profit (economics) , profitable market production process (business). Profit is a measure of profi ...
s when it is believed that accrual accounting concepts do not represent economic realities. For instance, 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. *cash flow can be used to evaluate the 'quality' of income generated by accrual accounting. When net
income Income is the Consumption (economics), consumption and saving opportunity gained by an entity within a specified timeframe, which is generally expressed in monetary terms. Income is difficult to define conceptually and the definition may be diff ...
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 notion is based loosely on cash flow statement accounting standards. The term is flexible and can refer to time intervals spanning over past-future. It can refer to the total of all flows involved or a subset of those flows. Within cash flow analysis, 3 types of cash flow are present and used for the cash flow statement: * perating cash flow- a measure of the cash generated by a company's regular business operations. Operating cash flow indicates whether a company can produce sufficient cash flow to cover current expenses and pay debts. *Cash flow from investing activities - the amount of cash generated from investing activities such as purchasing physical assets, investments in securities, or the sale of securities or assets. *Cash flow from financing activities (CFF) - the net flows of cash that are used to fund the company. This includes transactions involving dividends, equity, and debt.

Business' financials

The (total) net cash flow of a company over a period (typically a quarter, half year, or a full year) is equal to the change in cash balance over this period: positive if the cash balance increases (more cash becomes available), negative if the cash balance decreases. The total net cash flow for a project is the sum of cash flows that are classified in three areas: * Operational cash flows: cash received or expended as a result of the company's internal business activities. Operating cash flow of a project is determined by: **OCF = incremental earnings+depreciation=(earning before interest and tax−tax)+depreciation **OCF = earning before interest and tax*(1−tax rate)+ depreciation **OCF = (revenue − cost of good sold − operating expense − depreciation)* (1−tax rate)+depreciation **OCF = (Revenue − cost of good sold − operating expense)* (1−tax rate)+ depreciation* (tax rate) Depreciation*(tax rate) which locates at the end of the formula is called depreciation shield through which we can see that there is a negative relation between depreciation and cash flow. * Changing in net working capital: it is the cost or revenue related to the company's short-term asset like inventory. * Capital spending: this is the cost or gain related to the company's fix asset such as the cash used to buy a new equipment or the cash which is gained from selling an old equipment. The sum of the three component above will be the cash flow for a project. And the cash flow for a company also include three parts: *
Operating cash flow In financial accounting, operating cash flow (OCF), cash flow provided by operations, cash flow from operating activities (CFO) or free cash flow from operations (FCFO), refers to the amount of cash a company generates from the revenues it brings in ...
: refers to the cash received or loss because of the internal activities of a company such as the cash received from sales revenue or the cash paid to the workers. *Investment cash flow: refers to the cash flow which related to the company's fixed assets such as equipment building and so on such as the cash used to buy a new equipment or a building *Financing cash flow: cash flow from a company's financing activities like issuing stock or paying dividends. The sum of the three components above will be the total cash flow of a company.


The net cash flow only provides a limited amount of information. Compare, for instance, the cash flows over three years of two companies: Company B has a higher yearly cash flow. However, Company A is actually earning more cash by its core activities and has already spent 45M in long term investments, of which the revenues will only show up after three years.

See also

Capital gain Capital gain is an economic concept defined as the profit earned on the sale of an asset In financial accounting, an asset is any resource owned or controlled by a business or an economic entity. It is anything (tangible or intangible) th ...
* Cash flow sign convention * Cash flow hedge * Cash flow projection *
Cash flow statement In financial accounting, a cash flow statement, also known as ''statement of cash flows'', is a financial statements, financial statement that shows how changes in balance sheet accounts and income affect cash and cash equivalents, and breaks the ...
Investment Investment is the dedication of money to purchase of an asset to attain an increase in value over a period of time. Investment requires a sacrifice of some present asset, such as time, money, or effort. In finance, the purpose of investing is ...
Owner earnings Owner earnings is a valuation method detailed by Warren Buffett Warren Edward Buffett ( ; born August 30, 1930) is an American business magnate, investor, and philanthropist. He is currently the chairman and CEO of Berkshire Hathaway. He is ...
* Passive income *
Profit Profit may refer to: Business and law * Profit (accounting) Profit, in accounting, is an income distributed to the ownership , owner in a Profit (economics) , profitable market production process (business). Profit is a measure of profi ...
Return of capital Return of capital (ROC) refers to Principal (finance), principal payments back to "capital owners" (shareholders, partners, unitholders) that exceed the growth (net income/taxable income) of a business or investment. It should not be confused with ...
Return on equity The return on equity (ROE) is a measure of the profitability of a business in relation to the equity. Because shareholder's equity can be calculated by taking all assets and subtracting all liabilities, ROE can also be thought of as a return on '' ...


Further reading

* Auerbach, A. J., & Devereux, M. P. (2013).
Consumption and cash-flow taxes in an international setting
' (No. w19579). STICERD - Public Economics Programme Discussion Papers 03, Suntory and Toyota International Centres for Economics and Related Disciplines, LSE. National Bureau of Economic Research.

External links

A Review of Academic Research on the Reporting of Cash Flows from Operations
{{DEFAULTSORT:Cash Flow Accounting terminology Corporate finance Fundamental analysis