Cash Flow

Cash flow is the amount of money both going into, and out of, a company during the course of a period, normally a financial year.

Cash received (from customers buying the firm’s goods or services) are inflows, whereas money spent (payments for expenses, such as taxes or those expenditures accruing to other firms) are outflows.

Positive Cash Flow

Positive cash flow refers to the situation whereby money coming into the business exceeds that going out.

A company that cannot generate positive cash flow will not be able to generate returns for its owners and will thus not likely survive long.

A cash shortage is one of the main reasons for small business failure. If a firm has positive Free Cash Flow, it can cover all its expenses arising from its operations, maintain its asset base and have money left over for distribution to its owners and/or creditors.

Cash Flow In Trading

This data can be investigated via the Cash Flow Statement that a firm publishes (normally annually) on its sources and usage of cash.

There are three categories on the statement, namely;

  • Cash Flow from Operations (CFO)
  • Cash Flows from Investing (CFI)
  • Cash Flows from Financing (CFF)

The statement aims to reconcile the Balance Sheet (a snapshot of the firms’ assets and liabilities) and the Income Statement (an indication of a firm’s profits over a period), by recording ALL the company’s cash transactions over this time, showing the extent to which revenue booked via the Income statement have been collected.

Both investors and company management teams spend a large amount of time analysing cash flow trends, evaluating how firms use that money with the former looking for signs of changes in the speed and efficiency of cash collection.

Due to differences in the timing, sometimes there may be a difference between net income/earnings and cash flows, which need careful watching.

Although some can be considered relatively benign, such as rises in inventory levels, (bulk buying can often lead to lower purchase prices), but failure to collect debts due in a timely manner or falls in sales volumes or poor customer credit controls can often be an early warning sign of potential business failure ahead.

Both investors and the firm’s creditors want to be sure that the firm can continue to service its current debts, and one of the easiest ways to see this is to measure the ratio of current liabilities to operational cash flow, known as the debt service coverage ratio.