If you want to understand a business \u2013 either yours or someone else\u2019s \u2013 you need to have a working cash flow definition, as cash flow is the lifeblood of private enterprises. Without it, operations would cease, and the company would be compelled to discontinue trading, no matter how profitable it might be. <\/p>\n\n\n\n
In this post, we\u2019ll define what cash flow is and underscore how it differs from profit. We\u2019ll then list all the types of cash flow and differentiate them from one another.<\/p>\n\n\n\n
Accountants define cash flow as: <\/p>\n\n\n\n
The increase or decrease in cash of an organization during a specified accounting period.<\/p>\n\n\n\n
There are two sides to the cash flow equation: cash inflows and cash outflows. Inflows mainly come from sales, though sometimes they are donations, interest on loans, investments, royalties, and licensing agreements. Outflows include purchasing inventory and services from suppliers, as well as paying rent, wages, and petty cash expenses<\/a>.<\/p>\n\n\n\n Shareholders care about free cash flow (FCF) because it provides information on the company\u2019s ability to earn profits. Positive cash flow only arises if the total income generated by a company in a given period exceeds the money spent on everyday operations, after subtracting capital expenditure. Ultimately, the money that shareholders receive in the form of dividends (or in high stock prices in accumulating funds) comes from FCF, not profits, because that is the cash the company has physical access to.<\/p>\n\n\n\n Without sound cash flow, businesses fail even if they are profitable. Companies require cash on hand to pay their expenses. Otherwise, they must take out bridge financing or fail to pay suppliers and workers. <\/p>\n\n\n\n Having a firm grasp of financial flow lets organizations keep track of how much cash is available in their accounts and when. Moreover, proper reporting<\/a> enables companies to map out their ability to meet expenditures in the future. <\/p>\n\n\n\n If a company\u2019s annual cash flow is positive, it means that its liquid assets are increasing over time, allowing it to cover its obligations, such as rent, staff wages, and loan repayments. It also means that the enterprise can meet unexpected obligations, for instance, insurance premium hikes or fines<\/p>\n\n\n\n On the other hand, when cash flow is negative, it means the company is likely in distress. It\u2019s either spending beyond its means or its clients are not paying on time, delaying the entry of cash into the business. Ideally, companies should have enough cash on hand to buffer against these eventualities, but failing businesses may be struggling to meet all their obligations.<\/p>\n\n\n\n Businesses evaluate their cash flow position on the cash flow statement, a standard accounting document that companies must produce by law. It shows the company\u2019s starting and finishing cash totals for the period and the difference between them. <\/p>\n\n\n\n A company\u2019s finance department will evaluate the statement to see how the company is using its cash and project its likely cash position into the future. For publicly-traded companies, shareholders may evaluate CF statements to determine whether a company\u2019s share price is above or below fair value.<\/p>\n\n\n\n Cash flow tells you how cash is moving into and out of the enterprise. However, there are more specific cash flow calculations that companies and investors use to determine the health of their operations. <\/p>\n\n\n\n Financing cash flow shows the net flow of cash funding the company\u2019s capital assets. This metric tracks cash infusions from issuing equity while also tracking outflows, such as dividend payments. Investors use financing cash flow to better assess a company\u2019s financial strength and how well it is managing its capital structure. <\/p>\n\n\n\n Investing cash flow indicates the cash inflows and outflows from the company\u2019s investment-related activities over a specific period. Inflows might include dividends from shares in other companies that the business owns, while outflows could encompass purchases of other enterprises or equities. How well the company\u2019s capital is performing can be deduced from the investing cash flow. <\/p>\n\n\n\n Operating cash flow<\/a> specifies the inflows and outflows of cash associated with a company\u2019s regular operations. To calculate whether operating cash flow is positive or negative, enterprises take net income, add non-income expenses, and then subtract increases in working capital. <\/p>\n\n\n\n Based on operating cash flow, a company can decide whether it can expand its operations. Companies with limited cash flow may have to consolidate or scale back, while those with healthy flows can open new outlets or grow in new markets.<\/p>\n\n\n\n Free cash flow to equity is a term that some businesses use to describe the amount of cash left to reinvest into the business as capital expenditure. This is helpful for companies looking to expand as they will have the necessary financing to enable their business to grow.<\/p>\n\n\n\n In line with the cash flow meaning described above, you\u2019d be forgiven for thinking that cash flow and profit were the same. However, they are entirely different concepts. <\/p>\n\n\n\n Cash flow describes money going in and out of a business. Some enterprises calculate it by tallying up credit and debit, while others make corrections to net income. For instance, a company might have excellent cash flow for an accounting period because it refuses to pay a supplier. Naturally, its cash on hand goes up. However, that same entity could still wind up losing money long-term if insufficient funds come in to cover its expenses. <\/p>\n\n\n\n Likewise, suppose that a company has negative cash flow because a client won\u2019t pay on time. Its business cash flow might be negative for that particular period, but if the customer ultimately pays, it still could find itself recording profit. <\/p>\n\n\n\n Overall, cash flow and profit tend to track each other closely over long periods of time. However, over shorter horizons, such as weeks and months, they can vary dramatically. <\/p>\n\n\n\n Here are some examples of cash flow being used to calculate other metrics:<\/p>\n\n\n\n Because having money on hand is essential for the operation of enterprises, many invest tremendous resources in developing powerful cash flow systems. How each company approaches this task depends on the strategy its management has adopted.<\/p>\n\n\n\n In general, businesses can improve cash flow by:<\/p>\n\n\n\n To increase revenues, a company might increase prices, attract new customers, get referrals, or improve its marketing leads. Some companies, like Apple, do this by regularly launching new products and product categories on the market. <\/p>\n\n\n\n To increase operating margins, companies can automate tasks, negotiate more favorable deals with suppliers, or slash their payroll budget. These measures are sometimes referred to as cost-cutting.<\/p>\n\n\n\n Lastly, enterprises can improve the efficiency of their plants, property, and equipment by investing in proprietary technology, finding ways to reduce capital resource usage, or improving inventory management (using inventory management software<\/a> can help, for example).<\/p>\n\n\n\n If you are an entrepreneur, having a clear cash flow definition in your mind is critical for operational success. Once you understand the value of this metric, you can use it to predict how your business will perform and protect it against unexpected cash squeezes in the future.<\/p>\n","protected":false},"excerpt":{"rendered":" If you want to understand a business \u2013 either yours …<\/p>\nWhy Is Understanding Cash Flow So Important?<\/h2>\n\n\n\n
Types of Cash Flows<\/h2>\n\n\n\n
Financing Cash Flow<\/h3>\n\n\n\n
Investing Cash Flow<\/h3>\n\n\n\n
Operating Cash Flow<\/h3>\n\n\n\n
Free Cash Flow To Equity<\/h3>\n\n\n\n
What Is the Difference Between Profit and Cash Flow?<\/h2>\n\n\n\n
In contrast, profits measure a company\u2019s financial success. They are what remains after a company has paid all its obligations in a given accounting period. <\/p>\n\n\n\nWhat Do Companies Use Cash Flow For?<\/h2>\n\n\n\n
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How To Build Better Cash Flow<\/h2>\n\n\n\n
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Bottom Line<\/h2>\n\n\n\n