Cash flow

Cash flow refers to the outflows and net 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 essential information to know the status of the company. It is a good tool to measure the liquidity level of a company.

Solvency Definition

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

Net cash flow as a measure of solvency

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 the payments that have already been received, unlike net income , which includes accounts receivable and other items for which payments have not actually been received. Cash flow is used to assess the quality of a company’s income, that is, its ability to generate money, which can indicate whether the company is in a position to remain solvent.

If we find a positive net cash flow it 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 declining.

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

  • See difference between income and collection
  • See difference between expense and payment
  • See difference between gross and net

Some examples of income are the money obtained from sales, the collection for rentals or the collection of debts. And some examples of expenses can be the rent of the workplace, wages of workers and purchase of raw materials.

Types of cash flows

  • Cash flows from operations (FCO): Money entered or spent for activities directly related to that of the company.
  • Investment cash flows (FCI): Money entered or spent as a result of having dedicated money to a product that will benefit us in the future, for example, machinery.
  • Financial cash flow (FCF): Money entered or spent as a result of operations directly related to money, such as the purchase of a part of a company, payment of loans, interest.

Cash flows are widely used to analyze the viability of projects. They are the basis for the calculation of the Net Present Value (NPV)  and the  Internal Rate of Return (IRR ).

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