What is cash flow and why is it important for businesses?

By Indeed Editorial Team

Updated 11 January 2023

Published 3 January 2022

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

Cash flow represents the movement of cash through a company. It means managing finances and tracking trends for the business owner to know how much they're making so that they can plan for future projects and growth. Generally, when businesses have good cash flow, they can hire more staff, buy more equipment and invest in new areas without worrying about their financial situation. In this article, we discuss the question 'what is cash flow?', outline types of cash flow, discuss its overall importance and answer frequently asked questions.

What is cash flow?

If you're new to accounting, you might be wondering, 'What is cash flow?'. Cash flow is the amount of money coming into a business minus the amount of money going out. Maintaining cash flow is like balancing your chequebook. You have deposits, money that goes in, and withdrawals, money that comes out of your account. Cash flow exists to make sure your bank account stays healthy. In business, cash flow ensures a company stays in operation and ultimately increases its long-term success.

Why is cash flow important?

Cash flow helps keep businesses organised. Many companies use cash flow reports to help them with their budgeting process. Cash flow can also represent the total amount of income before the company pays any expenses for goods or services provided by an organisation. When businesses have low cash flow, they may cut back on staff and purchases to avoid going into debt.

Related: 9 essential accounting skills for career success

Types of cash flow

Cash flow is part of a company's financial statement. It includes sources of revenues, operating activities, investing activities, and financing activities. Below are some of the types of cash flow shown on a financial statement:

  • Net present value: This discounted cash flow equation evaluates investments in businesses. It considers all costs and revenues over the life of the investment.

  • Liquidity: Liquidity measures how well a company can meet its financial obligations and the amount of cash it has on hand.

  • Cash flow per share: For this, you divide the company's earnings by the number of shares outstanding to give a figure for cash flow per share. This is the bottom-line figure for investors to consider when evaluating a company's continuing success in terms of its value.

  • Cash conversion ratio: The cash conversion ratio is a metric that evaluates how long it takes for the company to receive payment from their customers in relation to when you paid for inventory.

  • Cash flow from operating activities: For this, you subtract the cash used in operating activities from the cash generated from operating activities.

  • Funding gap: This is how much you need in cash to overcome a shortfall.

  • Dividend payments: Dividends are the profits that are left over after the company pays all its expenses, meaning there is still money left over for shareholders to receive.

  • Capital expenditures: These are the investments that a business reinvests into its business.

  • Free cash flow to equity: This is the cash flow that comes in from business operations minus capital expenditures.

  • Free cash flow to the firm: This measurement assumes a company is not under debt. It relates to the valuation of a company.

  • Net change in cash: This is the net change in cash flow from one accounting period to another.

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What does a cash flow statement include

Here are some of the elements of a cash flow statement:

Operating activities

Companies use operating activities to increase the value of their business. For example, if you sell a product, production, sales and delivery of that product are all operating activities for your business. Other examples of operating activities include:

  • payment from customers

  • purchase of inventory

  • accounts payable

  • company payroll

  • depreciation on equipment or other tangible assets

  • amortisation of intangible assets and

  • deferred tax

Investing activities

This type of cash flow includes the sale or purchase of assets like equipment, buildings, land or marketable securities. Investing activities can also include loan payments received from customers. It also covers payments from acquisitions and mergers.

Financing activities

This includes cash to shareholders in the form of dividends and cash from investors. It can also include activities that impact long-term equities and liabilities. Examples of this are the repurchase or sales of company stock.

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Frequently asked questions about cash flow

Here are some questions that are frequently asked about cash flow:

What is the difference between cash flow and net income?

Net income is the total amount of money that a company has earned after subtracting expenses. You can calculate it by subtracting operating costs from revenue. Some call this revenue minus the cost of goods sold. Cash flow is how much money a company has left in the bank after covering all expenses. Cash flow does not always equal net income because cash can come in or go out when there are payments for inventory purchases, loans or capital investments.

What are some ways to preserve cash flow?

You can try selling more of a service or product than what you spend. Keeping a balanced chequebook, saving on costs through vendors, selling unnecessary assets and outdated equipment and building a reserve are other ways to preserve cash flow. You can also reduce unnecessary spending.

Why is it important to know what my future cash flow is?

Knowing your future cash flow can help your business stay successful. By knowing upcoming income and expenditures, you can determine what expenses to account for or what future endeavours are viable so as not to overspend. Analysts perform cash flow analysis with these four steps:

  • calculating expenditures such as payments due to vendors or suppliers and price increases for the business

  • analysing future sales by looking at forecasted trends in the industry and previous years' sales

  • determining upcoming expenses like the cost of doing business, capital investments and payroll

  • analysing information to see where to cut costs or where to make investments to ensure the business continues to grow and operate efficiently

What is positive and negative cash flow?

With positive cash flow, a business has enough money to continue to operate without loans. This helps your company to grow. With negative cash flow, you're spending more than what you're earning and may need loans to keep your company financially secure.

What are some examples of cash equivalents?

Cash equivalents are short-term investments that are highly liquid, meaning they convert easily into cash. They usually have a maturity date of three months or fewer. Some examples of cash equivalents include treasury bills, short-term government bonds, money market accounts or commercial paper.

What is the difference between cash flow and profitability?

A company has a high cash flow if they bring in more money than they spend on expenses. But this does not necessarily mean that the company makes a profit. A company might have very low expenses but not profit from their products or services if the majority of their costs go towards research and development or marketing campaigns, for example.

Why is it important to increase cash flow?

One way to increase the cash flow is by setting aside a certain percentage of profits for future use or by reinvesting it back into the company. This is 'cash-flow positive.' It can help you to avoid debt. Increasing cash flow helps businesses to be financially stable and allows them to have financial success year after year.

How can you manage cash flow easily?

For those new to cash flow, there is software that can help you manage it. Some programmes track time, expenses and profit. They can show you how much profit each project generates so that you can know what projects are most profitable and where your money is going.

What are the businesses with different types of cash flows?

In terms of cash flow, there are four different types of business, including:

  • Income-generating: These companies generate cash from selling products or services.

  • Fixed-income: These businesses have set revenue and expenses every period, so their cash flow stays the same from period to period.

  • Expense-generating: These companies incur expenses that are more than the sales they generate.

  • Asset-generating: These corporations sell assets such as real estate or equipment at a set price and collect the cash for these over time.

How can you grow your company with a more profitable cash flow?

To increase your company's cash flow, one way is to increase its profit margins. There are many ways that you can do this, but one way is by increasing your company's growth rate. Growth rates have a high correlation with profitability, which makes them a good metric for determining how well your company is performing financially.


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