Cash flow

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Cash flow refers to the movement of cash into or out of a business, or project, or financial product. It is usually measured during a specified, finite period of time. Measurement of cash flow can be used

• to determine a project's rate of return or value. The time of cash flows into and out of projects are used as inputs in financial models such as internal rate of return, and net present value.
• to determine problems with a business's liquidity. Being profitable does not necessarily mean being liquid. A company can fail because of a shortage of cash, even while profitable.
• as an alternate measure of a business's profits when it is believed that accrual accounting concepts do not represent economic realities. 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.
• cash flow can be used to evaluate the 'quality' of Income generated by accrual accounting. When Net Income is composed of large non-cash items it is considered low quality.
• to evaluate the risks within a financial product. E.g. matching cash requirements, evaluating default risk, re-investment requirements, etc.

Cash flow is a generic term used differently depending on the context. It may be defined by users for their own purposes. It can refer to actual past flows, or to projected future flows. It can refer to the total of all the flows involved or to only a subset of those flows. Subset terms include 'net cash flow', operating cash flow and free cash flow.

[edit] Statement of Cash Flow in a Business's Financials

Cash flows are classified into:

1. Operational cash flows: Cash received or expended as a result of the company's internal business activities. It includes cash earnings plus changes to working capital. Over the medium term this must be net positive if the company is to remain solvent.
2. Investment cash flows: Cash received from the sale of long-life assets, or spent on capital expenditure (investments, acquisitions and long-life assets).
3. Financing cash flows: Cash received from the issue of debt and equity, or paid out as dividends, share repurchases or debt repayments

All three together - the net cash flow - are necessary to reconcile the beginning cash balance to the ending cash balance.

[edit] Ways Companies Can Augment Reported Cash Flow

Common methods include:

• Sales - Sell the receivables to a factor for instant cash. (leading)
• Inventory - Don't pay your suppliers for an additional few weeks at period end. (lagging)
• Sales Commissions - Management can form a separate (but unrelated) company act as its agent. The book of business can then be purchased quarterly as an investment.
• Wages - Remunerate with stock options.
• Maintenance - Contract with the predecessor company that you prepay five years worth for them to continue doing the work
• Equipment Leases - Buy it
• Rent - Buy the property (sale and lease back, for example).
• Oil Exploration costs - Replace reserves by buying another company's.
• Research & Development - Wait for the product to be proven by a start-up lab; then buy the lab.
• Consulting Fees - Pay in shares from treasury since usually to related parties
• Interest - Issue convertible debt where the conversion rate changes with the unpaid interest.
• Taxes - Buy shelf companies with TaxLossCarryForward's. Or gussy up the purchase by buying a lab or O&G explore co. with the same TLCF.^[1]

[edit] Example of a positive $40 cash flow

In this example the following types of flows are included:

• Incoming loan: financial flow
• Sales: operational flow
• Materials: operational flow
• Labor: operational flow
• Purchased Capital: Investment flow
• Loan Repayment: financial flow
• Taxes: financial flow

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:

Company A:
Year 1: cash flow of +10M
Year 2: cash flow of +11M
Year 3: cash flow of +12M

Company B:
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:

Company A:

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

Company B:

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

• OC = Operational Cash, FC = Financial Cash, IC = Investment Cash

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.

[edit] See also

• Cash flow hedge
• Cash flow projection
• Cash flow statement
• Cash on cash return
• Discounted cash flow
• Free cash flow
• Income statement
• Internal rate of return
• Net present value
• Return of capital

[edit] References

[edit] External Lınks

• International Federation of Accountants International Good Practice Guidance on Project Appraisal Using Discounted Cash Flow