About this Book
Cash flow refers to the total amount of cash-equivalents or real cash that moves in and out of business. Cash flow can be either positive or negative. Positive cash flow refers to increase in the liquid assets of a company, which will make it easy for the said company to take care of its financial obligations, like saving for the future, paying expenses, paying shareholders, reinvesting in the business, settling debts, and so on.
Negative cash flow, on the other hand, means the liquid asset of the company is on the decline, which may make it impossible for the company to settle its various financial obligations. There is a difference between net cash flow and net income; the latter can include items for which the company has not received payment and account receivable. The quality of the income owned by a company can be assessed using cash flow phenomenon. It refers to how liquid the income is, and can give an insight into the possibility of the company remaining solvent.
Accrual accounting is one of the many aspects of cash flow analysis, and it enables a company to count their chickens before they hatch; this is because accrual accounting considers credit when calculating the income of the company. In this situation, the company can add settlement due from customers and accounts receivable as part of the items on its balance sheet. These may not count as cash, but they are added, anyway, as part of the cash flow of the company.
Cash inflow of a company can also be from the sales of its long-term assets. The company will, therefore, increase its liquidity, but at the same time, it will be limiting its growth potential in the long term; in such a situation, the company may be preparing itself for failure. A company can also borrow money and issue bonds to increase liquidity, but the outcome may also not be palatable in the long run. When considering the true state of a company, therefore, it is better to consider both the income statement and the cash flow statement of the company together.
Cash Flow Statement
This is also referred to as the statement of cash flow. This statement can adequately show if the income of the company is languishing or not, considering the number of IOUs in the statement. Having a high number of IOUs is never a sustainable situation for any company in the long term; neither does it translate into an increase in cash flow. Lack of cash-equivalent and real cash for settling short-term liabilities can render a company insolvent even if the company is very profitable. The company may not have the liquid cash for survival in the case of a lawsuit or business downturn if the profit recorded by the company is tied up in inventory, prepaid expenses and accounts receivable. The quality of a company’s income is determined by cash flow. The company should be deeply concerned if its net income is less than its cash flow.
Cash flow statement can be categorised into three, as highlighted below
1. Financing cash flow
2. Investing cash flow and
3. Operating cash flow
Operating cash flow represents cash flow that relates to the day-to-day operations of the company. Investing Cash Flow talks about the acquisitions and other investments of the company. The investment can be long-term or short-term; good examples of long-term investments are securities and towers for a telecommunication service provider. On the other hand, Financing Cash Flow talks about the creditors and investors of the company. It is also concerned with the dividends the company pays to its investors, as well as the cash received from bond issuance.
Free cash flow refers to the operating cash flow of a company minus its capital expenditures. The company can use this cash flow for expanding the business, paying off company debts, buying back stock and paying dividends.
In this text, you will learn about the various aspects of cash flow analysis. You will equally learn about how cash flow management works. The various cash flow challenges will equally be made known along the line, same for how to maintain a stable cash flow.