Origin
The term “cashflow” comes from the world of finance and refers to the amount of cash created or consumed by an organization during a given period. It was first used by financial analysts and investors in the mid-twentieth century to describe the movement of cash in and out of a company.
Definition
The cash inflows and outflows that occur throughout an accounting period are measured as cashflow. It is the net amount of cash generated or used by a corporation to finance its operations, investments, and financing activities.
Positive cashflow shows that a company’s cash inflow exceeds its cash outflow, whilst negative cashflow suggests the opposite.
Types
| Type of Cashflow | Description | Example |
|---|---|---|
| Operating Cashflow | Cash inflows and outflows that result from the day-to-day operations of a business | Revenue from sales, salaries and wages |
| Investing Cashflow | Cash inflows and outflows that result from the purchase or sale of assets, such as property, plant, and equipment | Purchase of new equipment, sale of property |
| Financing Cashflow | Cash inflows and outflows that result from raising or repaying capital | Issuing bonds, repaying bank loans |
Formula
Cashflow = Operating Cashflow + Investing Cashflow + Financing Cashflow
To calculate cashflow, you must first establish the cash inflows and outflows for each sort of cashflow and then add them together. This is an example of a step-by-step cashflow calculation:
Example:
Assume the Luis1k corporation has the following year-end data:
- Operating cash inflows: $100,000
- Operating cash outflows: $60,000
- Investing cash inflows: $20,000
- Investing cash outflows: $30,000
- Financing cash inflows: $50,000
- Financing cash outflows: $40,000
Calculation
Step 1: Determine Operational Cashflow
Operating Cashflow = Operating Cash Inflows – Operating Cash Outflows Operating Cashflow
= $100,000 – $60,000
Operating Cashflow = $40,000
Step 2: Determine Investment Cashflow
Investing Cashflow = Investing Cash Inflows – Investing Cash Outflows
Investing Cashflow = $20,000 – $30,000
Investing Cashflow = -$10,000
Step 3: Determine Financing Cashflow
Financing Cashflow = Financing Cash Inflows – Financing Cash Outflows
Financing Cashflow = $50,000 – $40,000
Financing Cashflow = $10,000
Step 4: Determine Cashflow
Cashflow = Operating Cashflow + Investing Cashflow + Financing Cashflow
Cashflow = $40,000 + (-$10,000) + $10,000
Cashflow = $40,000
The corporation has a cashflow of $40,000 in this case. This means that the corporation made more money than it spent over the year.
Good cashflow is a good indicator for businesses since it means they have more money to reinvest in the company, pay off debt, or give to shareholders.
Categories
Positive
Apple Inc.
Apple Inc. is a well-known example of a cash-flow positive corporation. In recent years, the corporation has made large sums of money through the sale of its popular iPhones, iPads, and other devices.
Because of this positive cash flow, the company has been able to invest in new initiatives, pay off debt, and give dividends to shareholders.
Negative
Shop Apotheke is a European online pharmacy and healthcare company that has recently faced negative cash flow. Despite this, the company has continued to invest in expansion possibilities and has experienced great sales growth.
It is important to note that negative cash flow in the short term is not always an indication of financial instability, but rather of a corporation investing in growth possibilities to attain long-term success.
Meaning for company
A positive cash flow generally implies that a business is doing well because it signifies the business is making more cash than it is spending. This could be due to high sales, efficient cost management, or other factors that lead to good cash flow.
A negative cash flow, on the other hand, can suggest that a firm is not doing well financially, as it signifies that the organization is spending more money than it is making. This could be due to a variety of factors, including high operational expenses, low sales, or an investment in long-term assets.
However, It is crucial to emphasize that negative cash flow is not always a bad thing. Companies will sometimes invest in growth prospects that entail considerable upfront costs, such as R&D or expanding into new markets. In certain circumstances, negative cash flow may be a crucial component of the company’s long-term success strategy.
Importance
1. Liquidity: Cash flow reflects a company’s capacity to cover short-term obligations such as salary payments, inventory purchases, and debt repayments. A good cash flow indicates that a business has adequate liquid funds to meet its expenses and continue operations.
2. Investment: Good cash flow indicates that a company has the capital to invest in chances for growth, such as growing its business, acquiring new assets, or hiring more personnel.
3. Solvency: Cash flow is an important measure of a company’s long-term financial sustainability. Negative cash flow can lead to insolvency and bankruptcy, whereas positive cash flow can enable a company keep running and pay its debts.
4. Creditworthiness: The ability of a company to create cash flow is an important criterion that lenders and creditors examine when assessing its creditworthiness. A company with a solid cash flow history is more likely to get favorable financing arrangements than one with a negative or inconsistent cash flow history.
Pros and Cons of reinvesting cashflow
• Growth: Reinvesting cash flow can assist businesses in funding new projects, expanding operations, and pursuing new growth prospects. In the long run, this can lead to higher income and profitability.
• Competitive advantage: By reinvesting cash flow, businesses can remain competitive by investing in R&D, upgrading technology, and enhancing processes.
• Tax advantages: In some situations, reinvesting cash flow can result in tax advantages, like as deductions for R&D expenses or accelerated depreciation on new equipment.
• Improved shareholder value: If reinvesting cash flow results in increased revenue and profits, it has the potential to increase the company’s value and benefit shareholders through higher stock prices or dividends.
Cons
• Risk: Reinvesting cash flow in new initiatives or businesses is risky, and there is always the possibility that the expected returns may not be realized.
• Opportunity cost: When a corporation reinvests cash flow in new projects, it may forego other investment opportunities, such as acquiring a competitor or investing in a more successful endeavor.
• Decreased dividends: If a corporation reinvests a large portion of its cash flow, it may not have as much available to pay out to shareholders in dividends.
Direct cashflow
The direct method begins with client cash receipts and cash payments to suppliers and staff. It reports cash inflows and outflows for each activity directly, resulting in a more thorough report.
The direct approach formula for estimating cash flow from operating activities is as follows:
Cash receipts from customers – Cash paid to suppliers – Cash paid to employees
= Cash flow from operating activities
Step-by-Step Calculation
If a business has the following cash collections and payments during the fiscal year:
• Cash receipts from customers = $500,000
• Cash paid to suppliers = $300,000
• Cash paid to employees = $100,000
2. We may compute the cash flow from operating operations using the formula above as follows:
Cash flow from operating activities = $500,000 – $300,000 – $100,000
Cash flow from operating activities = $100,000
3. Using the direct method, the cash flow from operational activities for this company is $100,000.
Indirect method
The indirect method begins with net income and then adjusts it for non-cash items and working capital changes. It begins with the income statement and adjusts for non-cash factors such as depreciation as well as changes in working capital such as accounts receivable, inventories, and accounts payable.
The indirect method’s formula for computing cash flow from operating operations is as follows:
Net income + Non-cash expenses – Changes in working capital = Cash flow from operating activities
Calculation Process:
1. Assume a business has the following information:
Net income = $150,000
Depreciation expense = $20,000
Increase in accounts receivable = $30,000
Decrease in inventory = $10,000
Increase in accounts payable = $15,000
2. Using the formula above, we can calculate the cash flow from operating activities as follows:
Cash flow from operating activities = $150,000 + $20,000 – $30,000 + $10,000 – $15,000
Cash flow from operating activities = $135,000
3. Using the indirect method, the cash flow from operating operations for this company is $135,000 each year.
Examples
A retail store that predominantly deals in cash sales, with easy-to-track cash inflows and outflows, is an example of a corporation that might adopt the direct method.
A manufacturing firm that deals with a lot of credit sales and purchases, where it may be more difficult to manage cash inputs and outflows, is an example of a company that might employ the indirect technique.
Price-to-cash ratio
The price-to-cash flow ratio is a financial statistic that compares the value of a company’s stock price to its cash flow. It is computed by dividing the company’s market capitalization by its operating cash flow.
Formula:
Market capitalization / Operational cash flow = Price-to-cash flow
The following are the processes for calculating the price-to-cash flow ratio:
1. Determine the company’s market capitalization: The current stock price multiplied by the number of outstanding shares yields this figure.
2. Determine the company’s operating cash flow: This information is available on the company’s cash flow statement, which is included in its financial statements. The cash generated by the company’s routine business operations is referred to as operating cash flow.
3. The price-to-cash flow ratio is calculated by dividing the market capitalization by the operating cash flow.
Example
Assume the Luis1k company has a $1 billion market capitalization and a $200 million operating cash flow.
Applying the calculation, Luis1k’s price-to-cash-flow ratio would be:
P/C = $1 billion / $200 million = 5
Interpretation
A price-to-cash-flow ratio of 5 shows that the stock price of the firm is valued at 5 times its operating cash flow. A lower price-to-cash flow ratio generally implies that the company is undervalued, whereas a greater ratio indicates that the company is overvalued.
To acquire a better grasp of the company’s valuation, compare the ratio to industry peers and historical values.
Cash flow margin
The cash flow margin is a financial indicator that compares the amount of cash generated by a company to its revenue. It is computed as a percentage by dividing the cash flow from operations by the total revenue of the business.
The cash flow margin is calculated using the following formula:
Cash Flow Margin = Operating Cash Flow / Total Revenue times 100%
A high cash flow margin shows that a company generates a substantial quantity of cash from its activities in comparison to its revenue. This is a good sign for investors since it indicates that the company is efficient and effective at managing its operations and generating cash.
Calculation
ABC Company’s cash inflows and outflows for the month of January are as follows:
Inflows of cash:
• Customer cash received: $50,000
• Interest from investments: $1,000
Outflows of cash:
• Supplier payments: $25,000
• Salary and benefits for employees: $10,000
• Rent and utilies: $5,000
• Taxes: $2,000
To determine Luis1k company’s cash flow in January, we would do the following:
1. Determine the time frame: January
2. Determine all cash inflows: $50,000 + $1,000 = $51,000
3. Total cash inflows: $51,000
4. Determine all cash outflows: $25,000 + $10,000 + $5,000 + $2,000 = $42,000
5. Total cash outflows: $42,000
6. Total cash outflows minus total cash inflows equals: $51,000 – $42,000 = $9,000
Improving cash flow
1. Boost sales: Increasing sales is one of the most effective strategies to enhance cash flow. This can be accomplished through increasing marketing efforts, extending the consumer base, or launching new products or services.
For example, a company selling handmade jewelry could boost sales by opening an online store, expanding its product line to include personalized items, and running targeted marketing on social media channels.
2. Decrease expenditures: Reducing expenses is another strategy to enhance cash flow. This can be accomplished by negotiating better supplier costs, cutting needless spending, or developing more cost-effective ways to run the business.
For example, a restaurant can cut costs by renegotiating supplier contracts, eliminating food waste, and introducing energy-efficient equipment.
3. Enhance inventory management: Improving cash flow by minimizing the amount of money held in unsold inventory can help improve inventory management.
A clothes shop, for example, can enhance inventory management by establishing a just-in-time inventory system, lowering inventory on hand, and shortening the time between when inventory is purchased and when it is sold.
4. Increase collections: Another effective strategy to increase cash flow is to improve collections. This entails collecting payments from clients on time and lowering the number of outstanding invoices.
For instance, an accounting firm can enhance collections by establishing clear payment terms with clients, following up with late payers, and adopting a system to manage outstanding invoices.
Building cash flow statement
General steps to build a cash flow statement for a company:
1. Begin with the period’s net income, which can be found on the company’s income statement.
2. Depreciation and amortization are examples of non-cash expenses.
3. Adjust for changes in working capital accounts such as receivable, payable, and inventory.
4. Add or deduct any profits or losses from investing or financing activities, such as asset sales or loan payments.
5. Add the results of steps 1-3 to calculate the cash flow from operating operations.
6. Adjust for any changes in long-term assets, such as property, plant, and equipment, as well as any purchases or sells of investments, to calculate the cash flow from investing operations.
7. To calculate the net cash change for the period, add the cash flows from operating, investing, and financing activities.
8. To calculate the ending cash balance for the period, add the beginning cash balance for the period to the net change in cash.
Example
• Net income: $100,000
• Depreciation and amortization: $20,000
• Accounts receivable at the beginning of the period: $50,000
• Accounts receivable at the end of the period: $70,000
• Accounts payable at the beginning of the period: $30,000
• Accounts payable at the end of the period: $40,000
• Purchase of property, plant, and equipment: $50,000
• Repayment of long-term debt: $25,000
• Issuance of stock: $10,000
Calculation
Step 1: Begin with $100,000 in net income.
Step 2: Subtract non-cash expenses to arrive at $20,000
Total = $120,000
Step 3: Account for changes in working capital:
Accounts receivable change = $70,000 – $50,000 = $20,000
Accounts payable change = $40,000 – $30,000 = $10,000
Total adjusted = $130,000
Step 4: Add or remove investment or financing gains or losses:
Investing activity cash flow = -$50,000
-$15,000 in cash flow from financial operations = $10,000 – $25,000
Step 5: Determine the cash flow generated by operating activities:
$130,000 – (-$50,000) – (-$15,000) = $195,000
Step 6: Determine the cash flow generated by investing activities = -$50,000
Step 7: Determine the cash flow generated by financing operations = -$15,000
Step 8: Add the cash flows from operations, investments, and financing:
$195,000 + (-$50,000) + (-$15,000) = $130,000
Step 9: Add the beginning cash balance to the net cash change:
Assume a $50,000 starting cash balance.
$50,000 + $130,000 = $180,000
The period’s ending cash balance is $180,000.
Real estate
The amount of money left over after all expenses have been paid is referred to as cash flow. This includes mortgage payments, property taxes, insurance, maintenance fees, and any other expenditures connected with owning and operating a property in real estate.
1. Long-term success in real estate investing requires positive cash flow. It allows you to meet your bills, perform essential repairs or modifications, and make a profit.
2. Real estate investors frequently use the cap rate (capitalization rate) to assess a property’s future cash flow. The cap rate is computed by dividing the net operating income (NOI) by the property’s acquisition price.
3. Vacancy rates, rent hikes or decreases, unanticipated expenses, and interest rate changes can all have an influence on cash flow.
4. A high cap rate generally suggests a larger potential for cash flow, but other considerations like as location, property quality, and local market trends must also be considered.
Calculate cash flow:
Assume you’re thinking about buying a $300,000 rental property. The rental income from the property is $4,000 per month, and you anticipate the annual expenses to be as follows:
• Property taxes per year: $4,000
• Insurance costs: $1,200 per year.
• Maintenance costs: $1,500 per year.
• Costs for property management: $3,600 per year
To determine the cash flow for this property, calculate the net operating income (NOI) and deduct the annual expenses from the NOI. The steps are as follows:
Step 1: Calculate the Gross Rental Income.
To calculate the annual gross rental revenue, multiply the monthly rental income by 12:
$4,000 each month multiplied by 12 equals $48,000 per year.
Step 2: Calculate Your Operational Costs
Total all of your annual expenses:
Yearly income of $4,000 + $1,200 + $1,500 + $3,600 = $10,300
Step 3: Calculate the Net Operational Income (NOI)
Subtract the annual expenses from the overall rental income for the year:
$48,000 – $10,300 = $37,700
Step 4: Calculate the Cash Flow:
Subtract the mortgage payment (if applicable) from the NOI to calculate the cash flow:
Assume you have a $18,000 annual mortgage payment in this example.
$37,700 – $18,000 = $19,700
In this example, the estimated annual cash flow for the rental property is $19,700.
Interpretation
A positive cash flow of roughly 6-8% of the property value each year is considered a decent return on investment for most rental properties.
In this example, if the property is purchased for $300,000, the expected yearly cash flow of $19,700 is a return on investment of around 6.6%, which is within the average range of what could be considered a good cash flow return.
Is a high cash flow necessary for success?
A high cash flow can surely make a company’s operations easier and provide more flexibility when it comes to investing in growth possibilities or covering unexpected expenses. But, as previously said, it is not the only factor determining success.
While Tesla had negative cash flow for several years, it was able to garner considerable investment from private investors and government subsidies, providing the funding needed to drive its growth.
This allowed Tesla to continue investing in R&D, creating additional facilities, and expanding its product line despite the fact that it was not generating positive cash flow.
FAQ
What is the cashflow quadrant?
Robert Kiyosaki developed the Cashflow Quadrant concept in his book “Rich Dad, Poor Dad.” It categorizes people into four groups depending on their sources of income and how they make money.
The four categories are as follows:
1. Employee: Someone who works for another person and is paid a salary or hourly wage.
2. Self-employed: Someone who owns their own business or works as a freelancer and makes their living solely through their own efforts.
3. Business owner: Someone who owns a company that is run by others and earns revenue for the owner.
4. Investor: Someone who makes money by investing in stocks, real estate, or other assets.
The secret to financial success, according to Kiyosaki, is to migrate from the left side of the quadrant (Employee and Self-employed) to the right side (Business owner and Investor). He argues that the left side of the quadrant has limited income potential and requires continuing effort and time to maintain, whereas the right side has larger income potential and more passive income sources.