Cash Flow: What It Is, How It Works, and How to Analyze It (2024)

What Is Cash Flow?

Cash flow is the net cash and cash equivalents transferred in and out of a company. Cash received represents inflows, while money spent represents outflows. A company creates value for shareholders through its ability to generate positive cash flows and maximize long-term free cash flow (FCF). Thisis the cash from normal business operations after subtracting any money spent on capital expenditures (CapEx).

Key Takeaways

  • Cash flow is the movement of money in and out of a company.
  • Cash received signifies inflows, and cash spent is outflows.
  • The cash flow statement is a financial statement that reports a company's sources and use of cash over time.
  • A company's cash flow can be categorized as cash flows from operations, investing, and financing.

Cash Flow: What It Is, How It Works, and How to Analyze It (1)

Formula and Calculation of Cash Flow

You can easily calculate a company's cash flow using the formula below. To do this, make sure you locate the total cash inflow and the total cash outflow.

CF = TCI - TCO

Where:

  • TCI = Total cash inflow
  • TCO = Total cash outflow

Understanding Cash Flow

Cash flow refers to the money that goes in and out of a business. Businesses take in money from sales as revenues (inflow) and spend money on expenses (outflow). They may also receive income from interest, investments, royalties, and licensing agreements and sell products on credit. Assessing cash flows is essential for evaluating a company’s liquidity, flexibility, and overall financial performance.

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 fare better, especially when the economy experiences a downturn, by avoiding the costs of financial distress.

Cash flows are analyzed using the cash flow statement, which is a standard financial statement that reports a company's cash source and use over a specified period. Corporate management, analysts, and investors use this statement to determine how well a company earns to pay its debts and manage its operating expenses. The cash flow statement is an important financial statement issued by a company, along with the balance sheet and income statement.

Cash Flow Statement

The cash flow statement acts as a corporate checkbook to reconcile a company's balance sheet and income statement. The cash flow statement includes the bottom line, recorded as the net increase/decrease in cash and cash equivalents (CCE).

The bottom line reports the overall change in the company's cash and its equivalents over the last period. The difference between the current CCE and that of the previous year or the previous quarter should have the same number as the number at the bottom of the statement of cash flows.

Types of Cash Flow

Cash Flows From Operations (CFO)

Cash flow from operations (CFO) describes money flows involved directly with the production and sale of goods from ordinary operations. Also known as operating cash flow, CFO indicates whether or not a company has enough funds coming in to pay its bills or operating expenses.

Operating cash flow is calculated by taking cash received from sales and subtracting operating expenses that were paid in cash for the period. Operating cash flow is recorded on a company's cash flow statement, indicates whether a company can generate enough cash flow to maintain and expand operations, and shows when a company may need external financing for capital expansion.

Cash Flows From Investing (CFI)

Cash flow from investing (CFI) or investing cash flow reports how much cash has been generated or spent from various investment-related activities in a specific period. Investing activities include purchases of speculative assets, investments in securities, or sales of securities or assets.

Negative cash flow from investing activities might be due to significant amounts of cash being invested in the company, such as , and is not always a warning sign.

Cash Flows From Financing (CFF)

Cash flows from financing (CFF) shows the net flows of cash used to fund the company and its capital. CFI is also commonly referred to as financing cash flow. Financing activities include transactions involving issuing debt, equity, and paying dividends.

Cash flow from financing activities provides investors insight into a company’s financial strength and how well its capital structure is managed.

How to Analyze Cash Flows

Using the cash flow statement in conjunction with other financial statements can help analysts and investors arrive at various metrics and ratios used to make informed decisions and recommendations.

Free Cash FlowFCF is a measure of financial performance and shows what money the company has left over to expand the business or return to shareholders after paying dividends, buying back stock, or paying off debt.
Unlevered Free Cash FlowUFCF measures the gross FCF generated by a firm that excludes interest payments, and shows how much cash is available to the firm before financial obligations.
Operating Cash FlowOCF is money generated by a company’s primary business operation.
Cash Flow to Net Income RatioThe ratio of a firm’s net cash flow and net income with an optimum goal of 1:1.
Current Liability Coverage RatioThis ratio determines the company’s ability to pay off its current liabilities with the cash flow from operations.
Price to Money Flow RatioThe operating money flow per share is divided by the stock price.

Example of Cash Flow

Below is Walmart's (WMT) cash flow statement for the fiscal year ending on Jan. 31, 2024. All amounts are in millions of U.S. dollars.

Cash Flow: What It Is, How It Works, and How to Analyze It (2)

Investments in and acquisitions of other businesses are accounted for in the cash flow from the investing activities section. Proceeds from issuing long-term debt, debt repayments, and dividends paid out are accounted for in the cash flow from the financing activities section.

Walmart's cash flow was positive, showing an increase of $1.09 billion, which indicates that it retained cash in the business and added to its reserves to handle short-term liabilities and fluctuations in the future.

How Are Cash Flows Different Than Revenues?

Revenue is the income earned from selling goods and services. If an item is sold on credit or via a subscription payment plan, money may not yet be received from those sales and are booked as accounts receivable. These do not represent actual cash flows into the company at the time. Cash flows also track outflows and inflows and categorize them by the source or use.

What Is the Difference Between Cash Flow and Profit?

Cash flow isn't the same as profit. Profit is specifically used to measure a company's financial success or how much money it makes overall. This is the amount of money that is left after a company pays off all its obligations. Profit is found by subtracting a company's expenses from its revenues.

What Is Free Cash Flow and Why Is It Important?

Free cash flow is left over after a companypays foritsoperating expensesandCapEx. It is the remaining money after items like payroll, rent, and taxes. Companies are free to use FCF as they please.

Do Companies Need to Report a Cash Flow Statement?

The cash flow statement complementsthe balance sheet and income statement. It is part of a public company's financial reporting requirements since 1987.

Why Is the Price-to-Cash Flows Ratio Used?

The price-to-cash flow (P/CF) ratio is a stock multiple that measures the value of a stock’s price relative to its operating cash flow per share. This ratio uses operating cash flow, which adds back non-cash expenses such as depreciation and amortizationto net income.

P/CF is especially useful for valuing stocks with positive cash flow but are not profitable because of largenon-cash charges.

The Bottom Line

Cash flow refers to money that goes in and out. Companies with a positive cash flow have more money coming in, while a negative cash flow indicates higher spending. Net cash flow equals the total cash inflows minus the total cash outflows.

Article Sources

Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in oureditorial policy.

  1. U.S. Securities and Exchange Commission. "Beginners' Guide to Financial Statements."

  2. U.S. Securities and Exchange Commission. "Explanation of Non-GAAP and Other Financial Measures."

  3. U.S. Securities and Exchange Commission. "Form 10-K," Page 5.

  4. FASB. "Summary of Statement No. 95."

Cash Flow: What It Is, How It Works, and How to Analyze It (2024)

FAQs

Cash Flow: What It Is, How It Works, and How to Analyze It? ›

Cash flow refers to money that goes in and out. Companies with a positive cash flow have more money coming in, while a negative cash flow indicates higher spending. Net cash flow equals the total cash inflows minus the total cash outflows. U.S. Securities and Exchange Commission.

What is cash flow analysis answer? ›

Cash flow analysis refers to the evaluation of inflows and outflows of cash in an organisation obtained from financing, operating and investing activities. In other words, we can say that it determines the ways in which cash is earned by the company.

How to analyze cash flow? ›

One can conduct a basic cash flow analysis by examining the cash flow statement, determining whether there is net negative or positive cash flow, pinpointing how the outflows compare to inflows, and draw conclusions from that. However, there is no universally-accepted definition of cash flow.

How does cash flow work? ›

Cash flow is a measure of how much cash a business brought in or spent in total over a period of time. Cash flow is typically broken down into cash flow from operating activities, investing activities, and financing activities on the statement of cash flows, a common financial statement.

What is cash flow statement answers? ›

A cash flow statement tells you how much cash is entering and leaving your business in a given period. Along with balance sheets and income statements, it's one of the three most important financial statements for managing your small business accounting and making sure you have enough cash to keep operating.

What is an example of a cash flow? ›

Examples of cash flow include: receiving payments from customers for goods or services, paying employees' wages, investing in new equipment or property, taking out a loan, and receiving dividends from investments.

How to analyze cash flow from financing activities? ›

Here are steps you can follow to calculate cash flow from financing activities:
  1. Determine issuances of equity. ...
  2. Calculate repurchases of equity. ...
  3. Determine issuances of debt. ...
  4. Calculate repayments of debt. ...
  5. Calculate capital lease issuances. ...
  6. Calculate capital lease repurchases. ...
  7. Subtract issuances from repurchases.
Oct 22, 2023

How to do a cash flow? ›

How to create a cash flow forecast in 4 steps
  1. Decide the period you want your cash flow forecast to cover.
  2. List all your income in your cash flow projection.
  3. List all your outgoings in your cash flow projection.
  4. Work out your running cash flow.

Why is cash flow important? ›

Your operating cashflow shows whether or not your business has enough money coming in to pay operating expenses, such as bills and payments to suppliers. It can also show whether or not you have money to grow, or if you need external investment or financing.

What is cash flow in simple words? ›

Cash flow refers to the net balance of cash moving into and out of a business at a specific point in time. Cash is constantly moving into and out of a business. For example, when a retailer purchases inventory, money flows out of the business toward its suppliers.

What is cash flow simplified? ›

Cash flow is an important indicator of a company and its financial performance, as it provides information on how the company manages its income, expenses and investments. Cash flow describes the flow of money in the company, i.e. how much cash is received and spent in the course of a period.

What are the three types of cash flow statements? ›

The three categories of cash flows are operating activities, investing activities, and financing activities. Operating activities include cash activities related to net income. Investing activities include cash activities related to noncurrent assets.

What are the objectives of cash flow analysis? ›

The primary objectives of cash flow analysis are: To determine the ability of a business to generate positive cash flows and meet its financial obligations. To identify the sources and uses of cash within the organization. To assess the timing and predictability of cash inflows and outflows.

What indicates a good cash flow? ›

Cash flow refers to money that goes in and out. Companies with a positive cash flow have more money coming in, while a negative cash flow indicates higher spending. Net cash flow equals the total cash inflows minus the total cash outflows. U.S. Securities and Exchange Commission.

What is the best way to monitor cash flow? ›

So, how do you manage cash flow effectively?
  1. Create cash flow forecasts. Cash flow forecasting serves as an effective early warning system for cash crunches. ...
  2. Make cash flow statements. Staying on top of your financial reporting is essential for tracking the cash position of your business. ...
  3. Analyse variances.
May 15, 2023

What is a good cash flow ratio? ›

A high number, greater than one, indicates that a company has generated more cash in a period than what is needed to pay off its current liabilities. An operating cash flow ratio of less than one indicates the opposite—the firm has not generated enough cash to cover its current liabilities.

What is the best way to visualize cash flow? ›

A Waterfall chart is suitable for showing cash flows. For example, here is an example that visually shows what expenses were deducted from the revenue earned and how much profit was left as a result. Clearly separating the colors of the increase and decrease makes it easier to understand.

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