Cash Flow

WHAT IS CASH FLOW

Name: - Divesh Babaria | Topic: - What is Cash Flow | Date :- 17-01-2022

Module Leader: - Mr. Sandeep Munjal

What Is Cash Flow?
The term cash flow refers to the net amount of cash and cash equivalents being
transferred in and out of a company. Cash received represents inflows, while money spent
represents outflows. A company’s ability to create value for shareholders is fundamentally
determined by its ability to generate positive cash flows or, more specifically, to maximize
long-term free cash flow (FCF). FCF is the cash generated by a company from its normal
business operations after subtracting any money spent on capital expenditures (CapEx).

UNDERSTANDING CASH FLOW

Cash flow is the amount of cash that comes in and goes out of a company. Businesses take
in money from sales as revenues and spend money on expenses. They may also receive
income from interest, investments, royalties, and licensing agreements and sell products
on credit, expecting to actually receive the cash owed at a late date.

The purpose of a cash flow statement is to provide a detailed picture of what happened to
a business’s cash during a specified period, known as the accounting period. It
demonstrates an organization’s ability to operate in the short and long term, based on
how much cash is flowing into and out of the business.

Positive cash flow indicates that a company's liquid assets are increasing, enabling it to
cover obligations, reinvest in its business, return money to shareholders, pay expenses,
and provide a buffer against future financial challenges. Companies with strong financial
flexibility can take advantage of profitable investments. They also fare better in
downturns, by avoiding the costs of financial distress.

Cash flows can be analyzed using the cash flow statement, a standard financial statement
that reports on a company's sources and usage of cash over a specified time period.
Corporate management, analysts, and investors are able to use it to determine how well a
company can earn cash to pay its debts and manage its operating expenses. The cash flow
statement is one of the most important financial statements issued by a company, along
with the balance sheet and income statement.

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This cash flow statement shows Company A started the year with approximately $10.75 billion in cash and
equivalents.

Cash flow is broken out into cash flow from operating activities, investing activities, and financing activities. The
business brought in $53.66 billion through its regular operating activities. Meanwhile, it spent approximately $33.77
billion in investment activities, and a further $16.3 billion in financing activities, for a total cash outflow of $50.1
billion.

The result is the business ended the year with a positive cash flow of $3.5 billion, and total cash of $14.26 billion.

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THE CASH FLOW STATEMENT IS TYPICALLY BROKEN INTO THREE
SECTIONS:

1. Operating activities

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 2. Investing activities

3. Financing activities

OPERATING ACTIVITIES
Operating activities detail cash flow that’s generated once the company delivers its regular
goods or services, and includes both revenue and expenses. Investing activities include
cash flow from purchasing or selling assets—think physical property, such as real estate or
vehicles, and non-physical property, like patents—using free cash, not debt. Financing
activities detail cash flow from both debt and equity financing.

Based on the cash flow statement, you can see how much cash different types of activities
generate, then make business decisions based on your analysis of financial statements.

Ideally, a company’s cash from operating income should routinely exceed its net income,
because a positive cash flow speaks to a company’s ability to remain solvent and grow its
operations.

It’s important to note that cash flow is different from profit, which is why a cash flow
statement is often interpreted together with other financial documents, such as a balance
sheet and income statement.

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HOW CASH FLOW IS CALCULATED

Now that you understand what comprises a cash flow statement and why it’s important
for financial analysis, here’s a look at two common methods used to calculate and prepare
the operating activities section of cash flow statements.

Cash Flow Statement Direct Method

The first method used to calculate the operation section is called the direct method, which
is based on the transactional information that impacted cash during the period. To
calculate the operation section using the direct method, take all cash collections from
operating activities, and subtract all of the cash disbursements from the operating
activities.

Cash Flow Statement Indirect Method

The second way to prepare the operating section of the statement of cash flows is called
the indirect method. This method depends on the accrual accounting method in which
the accountant records revenues and expenses at times other than when cash was paid or
received—meaning that these accrual entries and adjustments cause the cash flow from
operating activities to differ from net income.

Instead of organizing transactional data like the direct method, the accountant starts with
the net income number found from the income statement and makes to
undo the impact of the accruals that were made during the period.

Essentially, the accountant will convert net income to actual cash flow by de-accruing it
through a process of identifying any non-cash expenses for the period from the income
statement. The most common and consistent of these are depreciation, the reduction in

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the value of an asset over time, and amortization, the spreading of payments over multiple
periods.

HOW TO INTERPRET A CASH FLOW STATEMENT

Whenever you review any financial statement, you should consider it from a business
perspective. Financial documents are designed to provide insight into the financial health
and status of an organization.

For example, cash flow statements can reveal what phase a business is in: whether it’s a
rapidly growing startup or a mature and profitable company. It can also reveal whether a
company is going through transition or in a state of decline.

Using this information, an investor might decide that a company with uneven cash flow is
too risky to invest in; or they might decide that a company with positive cash flow is
primed for growth. Similarly, a department head might look at a cash flow statement to
understand how their particular department is contributing to the health and wellbeing of
the company and use that insight to adjust their department’s activities. Cash flow might
also impact internal decisions, such as budgeting, or the decision to hire (or fire)
employees.

Cash flow is typically depicted as being positive (the business is taking in more cash than
it’s expending) or negative (the business is spending more cash than it’s receiving).

Positive Cash Flow

Positive cash flow indicates that a company has more money flowing into the business
than out of it over a specified period. This is an ideal situation to be in because having an
excess of cash allows the company to reinvest in itself and its shareholders, settle debt
payments, and find new ways to grow the business.

Positive cash flow does not necessarily translate to profit, however. Your business can be
profitable without being cash flow-positive, and you can have positive cash flow without
actually making a profit.

Negative Cash Flow

Having negative cash flow means your cash outflow is higher than your cash inflow during
a period, but it doesn’t necessarily mean profit is lost. Instead, negative cash flow may be
caused by expenditure and income mismatch, which should be addressed as soon as
possible.

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Negative cash flow may also be caused by a company’s decision to expand the business
and invest in future growth, so it’s important to analyze changes in cash flow from one
period to another, which can indicate how a company is performing overall.

INVESTING ACTIVITIES
Cash flow from investing activities (CFI) is one of the sections on the cash flow statement
that reports how much cash has been generated or spent from various investment-related
activities in a specific period. Investing activities include purchases of physical assets,
investments in securities, or the sale of securities or assets.

Negative cash flow is often indicative of a company's poor performance. However,

negative cash flow from investing activities might be due to significant amounts of cash
being invested in the long-term health of the company, such as research and development.

Investing activities can include:

 Purchase of property plant, and equipment (PP&E), also known as capital

expenditures

 Proceeds from the sale of PP&E

 Acquisitions of other businesses or companies

 Proceeds from the sale of other businesses (divestitures)

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  Purchases of marketable securities (i.e., stocks, bonds, etc.)

 Proceeds from the sale of marketable securities

There are more items than just those listed above that can be included, and every
company is different. The only sure way to know what’s included is to look at the balance
sheet and analyze any differences between non-current assets over the two periods. Any
changes in the values of these long-term assets (other than the impact of depreciation)
mean there will be investing items to display on the cash flow statement.

FINANCING ACTIVITIES

Financing activities are transactions involving long-term liabilities, owner’s equity and
changes to short-term borrowings. These activities involve the flow of cash and cash
equivalents between the company and its sources of finance i.e. the investors and creditors
for non-trading liabilities such as long-term loans, bonds payable etc.

The cash flow from financing activities are the funds that the business took in or paid to
finance its activities. It’s one of the three sections on a company's statement of cash flows,
the other two being operating and investing activities.

In the cash flow statement, financing activities refer to the flow of cash between a business
and its owners and creditors. It focuses on how the business raises capital and pays back

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its investors. The activities include issuing and selling stock, paying cash dividends and
adding loans.

A positive number on the cash flow statement indicates that the business has received
cash. This boosts its asset levels. On the other hand, a negative figure indicates the
business has paid out capital such as making a dividend payment to shareholders or
paying off long-term debt.

Some examples of cash flows from financing activities are:

 Issuing bonds (positive cash flow)

 Sale of treasury stock (positive cash flow)

 Loan from a financial institution (positive cash flow)

 Repayment of existing loans (negative cash flow)

 Cash from new stock issued (positive cash flow)

 Payment of cash dividend to stockholders (negative cash flow)

 Purchase of treasury stock (negative cash flow)

 Repurchase of existing stock (negative cash flow)

 Redemption of bonds (negative cash flow)

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 REFERENCES
 Tim Stobierski (30-04-2020 How to read and understand a cash flow statement.)

Available at https://online.hbs.edu/blog/post/how-to-read-a-cash-flow-statement

 LJ Suzuki (07-08-2020 How to Solve Cash Flow Problems in Business.)

Available at https://cfoshare.org/blog/solving-cash-flow-problems/

 Adam Hayes (01-12-2021 What Is Cash Flow.)

Available at https://www.investopedia.com/terms/c/cashflow

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