Cash Flow Factors


Cash flow is the movement of money into or out of a business, project, or financial product. It is usually measured over a specified, finite period of time. Cash flow measurements can be used to calculate other parameters that give information on a company's value and situation.

Many international banknotes in US dollars, pounds, and other currencies, piled together.

Cash flows reflect cash entering or leaving the organization.


Statement of Cash Flow in a Business's Financial Statements

A business's Statement of Cash Flows illustrates its calculated net cash flow. The net cash flow of a company over a period (typically a quarter or a full year) is equal to the change in cash balance over this period: It's positive if the cash balance increases (more cash becomes available); it's negative if the cash balance decreases. The total net cash flow is composed of several factors:

  • Operational cash flows are received or expended due to the company's internal business activities. This includes cash earnings plus changes to working capital. Over the medium term, this must be net positive if the company is to remain solvent.

  • Investment cash flows are received from the sale of long-life assets or spent on capital expenditure, such as investments, acquisitions, and long-life assets.

  • Financing cash flows are received from the issue of debt and equity or paid out as dividends, share repurchases, or debt repayments.


Uses

Cash flow factors can be used for calculating parameters, such as:

  • To determine a project's rate of return or value. The cash flows into and out of projects are inputs in financial models, such as internal rate of return and net present value.

  • To determine problems with a business's liquidity. Being profitable does not necessarily mean being liquid. Even while profitable, a company can fail because of a cash shortage.

  • As an alternative measure of a business's profits when it is believed that accrual accounting concepts do not represent economic realities, for example, a company may be notionally profitable but generate 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 derive additional operating cash by issuing shares or raising additional debt finance.

  • It can be used to evaluate the "quality" of income generated by accrual accounting. When net income 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 is a generic term used differently depending on the context. Users may define it for their own purposes. It can refer to actual past or projected future flows, the total of all flows involved, or a subset of those flows.

Key Points

  • Cash flow factors can be used to calculate parameters to measure organizational performance.

  • Operational cash flows are those originating from the organization's internal business.

  • Financing cash flows are those originating from the issuance of debt or equity.
  • Investment cash flows originate from assets and capital expenditures.

Terms

  • Parameter – a variable kept constant during an experiment, calculation, or similar.

  • Liquidity – availability of cash over the short term: the ability to service short-term debt.

Source: Boundless Finance, https://ftp.worldpossible.org/endless/eos-rachel/RACHEL/RACHEL/modules/en-boundless-static/www.boundless.com/finance/textbooks/boundless-finance-textbook/capital-budgeting-11/cash-flow-analysis-and-other-factors-95/index.html
Creative Commons License This work is licensed under a Creative Commons Attribution-ShareAlike 4.0 License.

Back to '6.5: Cash Flow Analysis and Other Factors\'