What is ‘Cash Flow’
Cash flow is the net amount of cash and cash-equivalents moving into and out of a business. Positive cash flow indicates that a company’s liquid assets are increasing, enabling it to settle debts, reinvest in its business, return money to shareholders, pay expenses and provide a buffer against future financial challenges. Negative cash flow indicates that a company’s liquid assets are decreasing. Net cash flow is distinguished from net income, which includes accounts receivable and other items for which payment has not actually been received. Cash flow is used to assess the quality of a company’s income, that is, how liquid it is, which can indicate whether the company is positioned to remain solvent.
Cash Flow From Operating Activities .
Cash Flow From Investing Activities
Non-Operating Cash Flows
Price to Free Cash Flow
BREAKING DOWN ‘Cash Flow’
The accrual accounting method allows companies to count their chickens before they hatch, so to speak, by considering credit as part of a company’s income. «Accounts receivable» and «settlement due from customers» can appear as line items in the assets portion of a company’s balance sheet, but these items do not represent completed transactions, for which payment has been received. They do not, therefore, count as cash. (Note that the credit vs. cash distinction is not the same as it is in everyday terminology, proceeds from credit card transactions are considered cash once they are transferred.)
The opposite can also be true. A company may be receiving massive inflows of cash, but only because it is selling off its long-term assets. A company that is selling itself for parts may be building up liquidity, but it is limiting its potential for growth in the long term, and perhaps setting itself up to fail. In the same vein, a company may be taking in cash by issuing bonds and taking on unsustainable levels of debt. For these reasons it is necessary to view a company’s cash flow statement, balance sheet and income statement together.
Cash Flow Statement
Often called the «statement of cash flows,» the cash flow statement indicates whether a company’s income is languishing in the form of IOUs – not a sustainable situation in the long term – or is translating into cash flow. Even very profitable companies, as measured by their net incomes, can become insolvent if they do not have the cash and cash-equivalents to settle short-term liabilities. If a company’s profit is tied up in accounts receivable, prepaid expenses and inventory, it may not have the liquidity to survive a downturn in its business or a lawsuit. Cash flow determines the quality of a company’s income, if net cash flow is less than net income, that could be a cause for concern.
Cash flow statements are divided into three categories: operating cash flow, investing cash flow and financing cash flow. Operating cash flows are those related to a company’s operations, that is, its day-to-day business. Investing cash flows relate to its investments in businesses through acquisition, in long-term assets, such as towers for a telecom provider, and in securities. Financing cash flows relate to a company’s investors and creditors: dividends paid to stockholders would be recorded here, as would cash proceeds from issuing bonds.
Free cash flow is defined as a company’s operating cash flow minus capital expenditures. This is the money that can be used to pay dividends, buy back stock, pay off debt and expand the business.