Cash flow (also called net cash flow) is the balance of the amounts of cash being received and paid by a business during a defined period of time, sometimes tied to a specific project. Measurement of cash flow can be used
Cash flow as a generic term may be used differently depending on context, and certain cash flow definitions may be adapted by analysts and users for their own uses. Common terms (with relatively standardized definitions) include operating cash flow and free cash flow.
All three together - the net cash flow - are necessary to reconcile the beginning cash balance to the ending cash balance. Loan draw downs or equity injections, that is just shifting of capital but no expenditure as such, are not considered in the net cash flow.
The cash flow statement breaks the sources of cash generation into three sections: operational cash flows, investing, and financing. This breakdown allows the user of financial statements to determine where the company is deriving its cash for operations. For example, a company may be notionally profitable but generating little operational cash (as may be the case for a company that barters its products rather than selling for cash). In such a case, the company may be deriving additional operating cash by issuing shares, or raising additional debt finance.
Companies that have announced significant writedowns of assets, particularly goodwill, may have substantially higher cash flows than the announced earnings would indicate. For example, telecoms firms that paid substantial sums for 3G licenses or for acquisitions have subsequently had to write-off goodwill, that is, indicate that these investments were now worth much less. These write-downs have frequently resulted in large announced annual losses, such as Vodafone's announcement in May 2006 that it had lost £21.9 billion due to a writedown of its German acquisition, Mannesmann, one of the largest annual losses in European history. Despite this large "loss", which represented a sunk cost, Vodafone's operating cash flows were solid: "Strong cash flow is one of the most attractive aspects of the cellphone business, allowing operators like Vodafone to return money to shareholders even as they rack up huge paper losses.
In certain cases, cash flow statements may allow careful analysts to detect problems that would not be evident from the other financial statements alone. For example, WorldCom committed an accounting fraud that was discovered in 2002; the fraud consisted primarily of treating ongoing expenses as capital investments, thereby fraudulently boosting net income. Use of one measure of cash flow (free cash flow) would potentially have detected that there was no change in overall cash flow (including capital investments).
Common methods include:
|Transaction||In (Debit)||Out (Credit)|
|Sales (which were paid for in cash)||+$30.00|
In this example the following types of flows are included:
Let us, for example, compare two companies using only total cash flow and then separate cash flow streams. The last three years show the following total cash flows:
Year 1: cash flow of +10M
Year 2: cash flow of +11M
Year 3: cash flow of +12M
Year 1: cash flow of +15M
Year 2: cash flow of +16M
Year 3: cash flow of +17M
Company B has a higher yearly cash flow and looks like a better one in which to invest. Now let us see how their cash flows are made up:
Year 1: OC: +20M FC: +5M IC: -15M, total = +10M
Year 2: OC: +21M FC: +5M IC: -15M, total = +11M
Year 3: OC: +22M FC: +5M IC: -15M, total = +12M
Year 1: OC: +10M FC: +5M IC: 0, total = +15M
Year 2: OC: +11M FC: +5M IC: 0, total = +16M
Year 3: OC: +12M FC: +5M IC: 0, total = +17M
Now it shows that Company A is actually earning more cash by its core activities and has already spent 45M in long term investments, of which the revenues will only show up after three years. When comparing investments using cash flows always make sure to use the same cash flow layout.