What is Cash Flow and Why Is It Important?

0
17

Define Cash Flow

Cash flow in English is defined as the variation of the inputs and outputs of money in a given period, and information measures the financial health of a company.

The cash flow allows forecasting, enables a good management in finances, decision making and control of income, in order to improve the profitability of a company.

With this term, we can relate the statement of cash flows, which shows the cash used in operating, investing and financing activities, in order to reconcile the initial and final balances of that period.

The knowledge of the cash flows allows to offer valuable information of the company, therefore one of the most important annual accounts controls them, the cash flow statement.

You may also like to Read

What is Cash Flow

Cash flow refers to the net outflows and inflows of money that a company or project has in a given period.

Cash flows provide information about the company’s ability to pay its debts. Therefore, it is indispensable information to know the state of the company. It is a good tool to measure the level of liquidity of a company.

The difference in income and expenses, that is, the result of subtracting the income that the company has, the expenses it has to do we call it ‘net cash flow’. Cash flows are crucial for the survival of an entity, they provide very important information of the company, indicating if it is in a healthy economic situation.

Types of Cash Flows

There are the following types of cash flows:

  • Operational:  Main source of income of the company or other activities of investment and financing.
  • Investment:  Long-term assets acquisition activities such as plants, equipment, investments in current and non-current assets.
  • Financing:  Activities that influence the size and composition of capital, as well as the company’s loans.

Why Cash Flow is Important
Fundamental principles for managing cash

  1. Increase cash inflows through an increase in sales volume or price.
  2. Try to get the tickets done quickly, selling cash, ask for advances or reduce the terms of the credits.
  3. Reduce cash outflows through discounts to suppliers or customers or reduce inefficiencies in the production of the company.
  4. Delay the outflow of money, such as trying to extend the deadlines to suppliers.

Net Cash Flow as a solvency measure

If a company or a person does not have enough cash to support their business, it is said to be insolvent. Being insolvent for quite some time can lead to bankruptcy and business closure.

Net cash flow is payments that have already been received, as opposed to net income, which includes accounts receivable and other items for which the payments have not actually been received. Cash flow is used to evaluate the quality of a company’s income, that is, its ability to generate money, which can indicate if the company is able to remain solvent.

If we find a positive net cash flow means that our income has been greater than the expenses we have had to face. And, on the contrary, if the cash flow is negative it means that we have spent more than we have entered.

  • Positive cash flow: indicates that the company’s  current assets are increasing, allowing it to settle debts, reinvest in its business, return money to shareholders, pay expenses and provide a buffer against future financial challenges.
  • Negative cash flow: indicates that the company’s current assets are decreasing.

It is always advisable for the entrepreneur to have a positive cash flow because he will have more people interested in buying part of his business, banks that are willing to give him credit in the event that he is needed, creditors who are willing to give him merchandise in advance.

Examples of income are the money earned by sales, payment for rent or debt collection. And some examples of expenses can be the rent of the place of work, salaries of workers and purchase of raw materials.