Cash Flow

Bradford Toney
Updated At


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What is Cash Flow?

Cash flow is a term used in business finance that refers to the net amount of cash and cash-equivalents moving in and out of a business. It is a measure of a company's financial health and its ability to generate positive cash flow, which is essential for business operations, paying off debts, returning money to shareholders, investing in new opportunities, and ensuring a buffer against future financial challenges.

There are three types of cash flows:

  1. Operating Cash Flow: This is cash generated from the company's core business operations. It reflects how much cash is generated from a company's products or services.
  2. Investing Cash Flow: This is cash used for investing in assets, as well as the proceeds from the sale of other businesses, equipment or long-term assets.
  3. Financing Cash Flow: This is cash generated or spent on raising and repaying share capital and debt together with the payments of interest and dividends.
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Cash Flow vs. Profit

Cash flow and profit are both important financial metrics for a business, but they measure different things. Profit is the revenue remaining after deducting all costs and expenses related to generating the revenue. It is calculated on an accrual basis, meaning it includes revenue earned but not yet received and expenses incurred but not yet paid.

On the other hand, cash flow measures the actual cash generated or used during a specific period. A company might be profitable but have a negative cash flow if it has not yet collected its receivables or has high investment activities. Conversely, a company could have positive cash flow while not being profitable if it is collecting receivables or selling off assets.

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How to Calculate Cash Flow

Calculating cash flow involves subtracting the total cash outflows from the total cash inflows. The formula is as follows:

Cash Flow = Cash Inflows - Cash Outflows

Cash inflows can come from sales, loans, and investments, while cash outflows can be from expenses, loan repayments, or purchases of assets.

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Why is Cash Flow Important?

Cash flow is crucial for a business for several reasons:

  1. Solvency: Positive cash flow ensures that a business can meet its short-term liabilities and operational expenses.
  2. Growth: Cash flow provides the resources a business needs to invest in growth.
  3. Flexibility: With positive cash flow, a company has the flexibility to respond to unexpected challenges or opportunities.
  4. Indicator of Health: Consistent positive cash flow is a good indicator of a company's overall financial health.
  5. Attract Investors: Investors and creditors prefer businesses with strong positive cash flows as it shows the business has the ability to generate cash to pay back a loan or provide a return on investment.

In simple terms, cash flow is the money that is moving (flowing) in and out of your business in a month. Although it does seem sometimes that cash flow only goes one way - out of the business - it does flow both ways.

Cash is coming in from customers or clients who are buying your products or services. If customers don't pay at the time of purchase, some of your cash flow is coming from collections of accounts receivable.

Cash is going out of your business in the form of payments for expenses, like rent or a mortgage, in monthly loan payments, and in payments for taxes and other accounts payable.

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How does it relate to the three statement financials?

Cash flow is directly tied to the three financial statements of a business: the income statement, the balance sheet, and the cash flow statement. The income statement shows the profitability of the company, which may result in cash inflow. The balance sheet shows the company's assets, including its cash and cash equivalents. Lastly, the cash flow statement provides a detailed look at the company's cash inflows and outflows over a period of time.

  • Hayes, A. (2023, July 31). Cash flow: What it is, how it works, and how to analyze it. Investopedia.
  • Beers, B. (2021, May 16). What's More Important, Cash Flow or Profits? Investopedia.
  • American Express Business Trends and Insights. (2023, December 12). How to calculate cash flow (Formulas included). Business Class: Trends and Insights | American Express.
  • Chen, J. (2023, December 15). Income Statement: How to read and use it. Investopedia.
  • Fernando, J. (2024b, January 31). Balance Sheet: Explanation, components, and examples. Investopedia.
  • Murphy, C. B. (2024, January 26). Cash Flow Statement: What it is and examples. Investopedia.
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