Cash availability in a business at any point in time contributes significantly to its day-to-day liquidity condition. It is thus essential for any business to be aware of its cash flow periodically. To do so, one must, therefore, have a basic understanding of the flow of cash along with its forecasting methods.
Cash Flow Definition
Cash flow refers to the inflow and outflow of the amount of cash or its equivalents in business. It determines the amount of cash consumed or generated for a specified period. Its analysis also identifies the existing sources of the flow of cash along with a possible scope of inflows.
The current flow of cash for a given period is identified by reducing the opening balance of a given period from its closing balance. Once calculated, cash flows can result in a negative or positive balance. A positive balance implies that the company has sufficient cash to fulfil its immediate liquidity requirements, while a negative balance indicates a constricted liquidity.
The cash flow of a company must, however, be analysed along with the company’s income statement as well as a balance sheet to determine its actual liquidity position. Also, an increasing flow of cash may not always be a positive indicator and must be analysed thoroughly to arrive at a definitive conclusion.
Types of Cash Flow
Flow of Cash From Operations-It specifies the cash generated out of an entity’s core business activities. When preparing a cash flow statement, cash inflows and outflows from operations are recorded in the first section. Cash inflow here mainly includes the money received after the sale of goods or services. Outflows of cash from operations comprise operations expenditures such as rent payments, cost of goods sold, etc.
Flow of Cash From Investments- It represents any changes, i.e., increase or decrease in long term assets of a business. It can be represented by the purchase of fixed assets, any loans extended by the entity, any gains assumed on an investment fund and the likes.
Flow of Cash From Financing Activities-Cash inflow or outflow from financing activities is recorded if an increment or reduction in the long term, debts, liabilities, business capital or dividend is observed. A cash flow example from financing activities would encompass principal or interest payments, stock repurchase, dividends issued, liabilities incurred, etc.
Impact of Weak Cash Flow Management
Increase in inventory-Businesses often stock up the inventory to fulfil high demand from the market. Nevertheless, a sudden change in such demand can leave the inventories indisposed, thus strapping sizable cash, further creating operational challenges.
Long payment cycle- Allowing your creditors a long cycle for payment can mean cash invested in raw material for an extended duration, creating a strain on other financial aspects. It is thus critical to decide on the payment cycle that keeps cash flow from operations at optimum.
Overspending-Acquiring a new client or getting a high-volume order can push one towards spending more than they can afford. Nevertheless, in the absence of actual cash, it would only mean an added burden on the short-term liquidity sustenance for the business.
FAQs
Difference Between Cash Flow and Revenue?
In the case of revenue, it is only a measure of the amount of money a business is receiving, whereas cash flow involves a two-way flow.
Thus, in it, both inflow and outflow of cash are considered for the purpose of calculation. Also, revenue is strictly based on the conversion of investment made to business operations while cash flows also take into consideration financing activities.
Difference Between Cash Flow and Income?
The primary point of difference between a business’s cash flow and its income is defined by the cash accounting and accrual accounting measures undertaken. The adoption of these two separate methods primarily results in the difference between an income statement and a cash flow statement.
In the preparation of an income statement, the method of accrual accounting is followed, wherein an income or expenditure is recorded as and when it occurs, irrespective of the involvement of cash. In the latter, however, transactions are recorded only when they have been dealt in cash and not merely based on accrual
