Cash flow / Net cash flow
Cash flow, like income, concerns the difference between money coming in and money going out.
Cash Flow = Cash Inflows – Cash Outflows
The sum of incoming cash flows and outgoing cash flows over a specified period of time is called Net Cash Flow.
Net Cash Flow = Sum of inflows – Sum of Outflows
Over a given time period.
Cash flow and net cash flow are center stage in two kinds of business analysis.
- Financial Statement Analysis: Cash flow metrics are viewed as one measure of a company's financial position—especially its ability to meet current obligations and take action on short notice.
- Business Case and Investment Analysis: cash flows are viewed as the basic input and output of a proposed action. Cash flow estimates support further analysis with financial metrics such as Net Present Value (NPV), Internal Rate of Return (IRR), Return on Investment (ROI), and Payback Period.
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Cash Flow in FInancial Statement Analysis
In fiancial reporting, the Cash Flow Statement (usually called Statement of Changes in Financial Position) is one of four primary reporting instruments that publically traded companies publish quarterly and annually. The cash flow statement tells management and stockholders how much cash they have to work with and how much they gained or lost during the period. By contrast, the Income Statement (or Profit & Loss Statement, P&L) tells stockholders and taxing authorities what the company reports for earnings during a period. Reported earnings and changes in cash position are related to each other, but they are not the same thing.
The other 2 primary financial reporting statements are the Balance Sheet, and Statement of Retained Earnings. "Cash on hand" also shows up under "Current Assets" on the Balance Sheet.
The company's Net Cash flow for a given period is the difference between category sums for "Sources of Cash" and "Uses of Cash."
The company's cash on hand, as well as net cash gains or losses, are major components of financial statement metrics such as Working Capital, The Current Ratio, and Quick Ratio. A low Current Ratio, for instance, can mean the company is not well prepared to meet payroll or other short term obligations. For examples illustrating the meaning and calculation of these metrics, see Financial Metrics Pro.
Note that a cash flow statement does not, however, include some items found in the income statement, such as depreciation expense. Depreciation expense does not represent an actual cash payment during the reporting period, but rather an accounting charge against earnings.
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Cash Flow and Net Cash Flow in the Business Case and Investment Analysis
In the simplest kind of investment analysis, there may be only two cash flow events: The original investment (outflow) and collection of the returns (inflow). This scenario describes an investor who buys a certain kind of bond and then simply holds it until maturity (or an investor who makes a winning bet on a racehorse). Investment metrics such as simple return on investment, yield, and present value are still possible with such transactions.
In business, however, investments (or actions examined with business case analysis) typically bring a series of cash inflows and outflows over time. The resulting cash flow stream may look something like this:
When analysis forecasts a cash flow stream of this kind, management takes the analysis further with financial metrics designed to answer specifc kinds of questions (metrics refers to measurement). How do returns compare to investment costs? How does this investment (or action) compare to other potential uses of the same investment funds? Which possible course of action is the better business decision? In this way, projected cash flow and its analysis lie at the heart of the financial business case.
As an example, one business case scenario might line up the expected cash flow results for several time periods to create a cash flow stream such as this:
| Business Case Results | |||
| Timing | Total Cash Inflows | Total Cash Outflows | Net Cash Flow |
| Now | $0 | $100 | -$100 |
| Year 1 | $40 | $20 | +20 |
| Year 2 | $50 | $30 | +20 |
| Year 3 | $75 | $35 | +40 |
| Year 4 | $90 | $30 | +60 |
| Year 5 | $100 | $40 | +60 |
| Total | $355 | $255 | +$100 |
The action or acquisition under consideration is expected to bring a net cash flow of $100 over five years. But does this represent a good business decision? Can the returns be improved? Where are the risks? The level of detail in this table is the minimum data needed to begin answering such questions.
Note: Each column and row tells a story: Inflows continue to rise throughout the 5-year period, but so do total outflows. Management will want to use this understanding and the data behind it, for instance, to apply financial tactics: reduce costs, increase gains, accelerate gains. For an introduction to the primary cash flow financial metrics, see the topics in this free online encyclopedia for Net Present Value (NPV), Internal Rate of Return, Return on Investment, and Payback Period. For a comparison of these metrics and what they say about the cash flow stream, see "What is the Best Way to Summarize a Business Case?" For working examples, implementation guidance, and more in depth coverage of other cash flow metrics, see the spreadsheet tool Financial Metrics Pro.
In a nutshell, a business case summary should always include a net cash flow stream because it
- Shows actual inflow and outflow figures, which are important for budgeting and business planning.
- Provides the basis for calculating other financial metrics, such as NPV, DCF, IRR, and payback.
- Is the beginning point for management actions to manage and optimize overall results.
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