Cash flow
Definition and Importance
Cash flow is a term used in financial circles to describe the net amount of cash and cash-equivalents being transferred into and out of a business. It is a key indicator of a company's financial health, as it indicates the company's ability to pay its debts and fund its operating expenses. The concept of cash flow is central to almost all areas of finance including financial analysis, valuation, and corporate finance.
Types of Cash Flow
There are three main types of cash flow: operating cash flow, investing cash flow, and financing cash flow. Each type provides information about a different aspect of a company's financial performance.
Operating Cash Flow
Operating cash flow, also known as cash flow from operations, measures the cash generated by a company's normal business operations. This includes cash received from customers, cash paid to suppliers and employees, and cash paid for taxes and interest.
Investing Cash Flow
Investing cash flow is the cash used for investing in the long-term future of the company. This includes cash spent on property, plant and equipment (PP&E), as well as cash received from selling these assets. It also includes cash spent on investments like stocks and bonds, and cash received from selling these investments.
Financing Cash Flow
Financing cash flow is the cash received from or paid to investors and creditors. This includes cash received from issuing stocks or bonds, cash paid to shareholders as dividends, and cash paid to creditors as debt repayment.
Cash Flow Statement
The cash flow statement is one of the three main financial statements used by businesses (along with the income statement and balance sheet). It provides a detailed breakdown of a company's cash inflows and outflows during a specific period. The cash flow statement is divided into three sections corresponding to the three types of cash flow: operating, investing, and financing.
Operating Activities Section
The operating activities section of the cash flow statement shows the cash flows from the company's core business operations. This includes cash received from customers, cash paid to suppliers and employees, and cash paid for taxes and interest.
Investing Activities Section
The investing activities section of the cash flow statement shows the cash flows from the company's investment activities. This includes cash spent on property, plant and equipment (PP&E), as well as cash received from selling these assets. It also includes cash spent on investments like stocks and bonds, and cash received from selling these investments.
Financing Activities Section
The financing activities section of the cash flow statement shows the cash flows from the company's financing activities. This includes cash received from issuing stocks or bonds, cash paid to shareholders as dividends, and cash paid to creditors as debt repayment.
Cash Flow Analysis
Cash flow analysis is the process of examining a company's cash flow statement to assess its financial health. Analysts look at the cash flow from operations to see if the company is generating enough cash to cover its operating expenses. They also look at the cash flow from investing to see if the company is investing wisely in its future. Finally, they look at the cash flow from financing to see if the company is managing its debt and equity financing effectively.
Cash Flow Forecasting
Cash flow forecasting is the process of predicting a company's future cash flows. This is an important part of financial planning, as it helps the company plan for future expenses and investments. Cash flow forecasting involves estimating future sales, costs, and other factors that affect cash flow.
Free Cash Flow
Free cash flow is a measure of a company's financial performance that is often used by investors. It is calculated as operating cash flow minus capital expenditures. Free cash flow represents the cash that a company is able to generate after spending the money required to maintain or expand its asset base.