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Cash-flow finance Explained in 6 easy steps

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What is Cash Flow?

Cash flow is simply the net amount of cash and cash equivalents, which is transferred into and out of a business. At a fundamental level, the ability of the company to generate positive cash flow and maximize long-term free cash flow determines the company’s ability to create value for its shareholders. It is the increase or decrease in the amount of money owned by a business; in other words, the amount of money generated or consumed by a company within a specified time frame.

One of the primary objectives of financial reporting is assessing the timing and uncertainty, as well as the amount of cash flow. Accessing and understanding the cash flow statement is essential to access the company’s liquidity, flexibility overall and financial performance as this cash flow statement reports the business’ operating cash flow, cash flow investing, and financing.

Positive Cash flow

Positive cash flow refers to a situation where cash inflows within a particular period are much higher than the cash outflows within the same period. While it does not necessarily mean profit, it is usually due to the careful management of expenses and cash inflows. Significant positive and persistent cash flow is an indication that the stocks of raw materials are not appropriately kept, and the company might be losing sales owing to shortages.

Negative Cash flow

Negative cash flow, on the other hand, refers to a situation where the business’ outgoing income surpasses its incoming revenue. It is a particularly common situation for new companies. It means that the business is losing money. It may however just be a reflection of the unfortunate timing of the business’ income and expenses.

Types Of Cash flow

To have a proper understanding of cash flow, it is essential that you have an understanding of the different kinds of cash flow. To provide clarification on which is being used,  the statement of cash flow thus separates this into three categories;

  1.  OPERATING CASH FLOW:

This form of cash flow refers to cash flow generated from operating activities. These operating activities include the day to day activities of the business, which include making sales and purchasing raw materials. Operating cash inflows are from cash sales and accounts collection receivable. Cash outflows basically refers to revenue generated from the major activities of the business. To generate these revenues, operations such as raw material purchases and payment of salaries have to be carried out. These cash outflows are then deducted from the cash inflows, and the resultant amount is the operating cash flow, also known as the net cash flow from operating activities.

  1. INVESTING CASH FLOW:

Investing cash flow refers to all income derived from investing activities, which includes the purchase as well as the sale of long-term assets and other investments. Cash outflows are generated from investments, which include long-term assets, property, plants, and equipment, all long-term and short-term investments in equity to mention just a few.  

Cash flow generated from buying securities and assets either for trading activities or for a primary business activity of the company is not included in the investing cash flow. Investing cash inflows also include the sale of non-trading securities such as property, plant and equipment, and other long-term assets. After which the cash outflows are then deducted from the cash flow, the result is then known as investing cash flow.

  1.  FINANCING CASH FLOW:

This cash flow is obtained from conducting the financial activities of a business. It includes obtaining or repaying capital, which could be either equity or long-term debt. Cash flow finance includes cash receipts from issuing stock and bonds as well as borrowing through long term loans.  Cash outflows, on the other hand, include all cash payments to repurchase stock, repay bonds as well as other borrowings. Financing cash flow is obtained by deducting financing cash outflow from financing cash inflow. 

Uses Of Cash flow

There are quite a number of uses of cash flow in business operations and performing financial analysis; it is therefore an important metric in finance and accounting. These cash metrics and their uses include;

  • Net Present Value: refers to the value of all future cash flows both positive and negative over the life of an investment and its discount to the present. Cash outflows help to calculate the value of a business by building a Discounted Cash Flow Model which is a forecast of the company’s unrevealed free cash flow and calculating the Net Present Value.
  • Liquidity: cash flow helps in assessing how well a business can meet its financial short-term obligations.
  • Cash Flow Yield: this helps in measuring how much cash a business generates on each share as it is relative to the price expressed as a percentage.
  • Internal Rate of Return: cash flow helps in determining the discount that sets the net present value of an investment equal to zero (IRR) which an investor achieves for making an investment.
  • Cash Conversion Ratio; cash flow helps in calculating the amount of time between when a business pays its inventory (the cost of goods sold) and when it receives payment from its customers (Cash Conversion Ratio)
  • Cash flow is used to fund the business’ dividend payment to investors.

How To Improve Your Company’s Cash Flow

The need for more money to settle business expenses as well as to be invested into the company often leads to burn rate or cash flow problems.  This is usually the case in venture-backed businesses and startups.

Unfortunately, many businesses often use quick patch up fixes to provide this capital, which often leads to low-quality financial standing as the business inevitably runs into more debt and is unable to remain solvent. Even while making profit, with little or no cash to balance, the business may resort to taking out even more loans with high debt services in order to keep it afloat.

Hence, to improve your company’s cash flow, it is necessary that all discounts be deposited and payments be made in cash or credit cards. Also buying equipment upfront will improve your company providing you with significant advantage as you will not then pay for the products’ depreciation. Spending smarter and developing a good spend culture is also crucial for improving the cash flow of your company.

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