Cash Flow

Cash flow refers to the total or net amount of cash and its equivalents that move in and out of an organization. If a cash flow is deemed positive that means the liquid assets of the company it belongs to are increasing allowing said company to take care of debts, reinvest in the business, pay expenses and store enough away to face future challenges. A negative cash flow on the other hand, is different from net income such as accounts receivables and other products which have not been paid for yet.

A breakdown of cash flow

Cash flow is generally used to determine the quality of an organization’s income i.e. its liquidity and whether the organization can remain solvent. This accounting method allows companies to count credit as part of their income.

Settlement that is due from customer and account receivables do not represent transactions for acquired payments so they cannot be called cash per se. Proceeds received from credit card transactions are only considered cash once the amount has been transferred.

A company that is receiving large cash amounts might be doing so because it is selling off large assets in one go. An organization that sells in parts may be trying to create liquidity but at the same time it limits its growth potential and may even be setting itself up for failure in the future.

Similarly, a company may be acquiring cash by issuing bonds and adopting debt levels that are unsustainable. This is why it is important that a company keeps its balance sheet, cash flow statement and income statement in one place.

What is a Cash Statement?

A cash statement or statement of cash flow determines whether an organization’s income is best with IOUs or whether its income is resulting in a sustainable cash flow. Even companies that seem successful can become insolvent if they are incapable of providing cash to take care of short term debts.

Plus if the income is being utilized for accounts receivables, inventory or other expenses, the business might not have the liquidity it needs to sustain itself in case of a downturn in the future. In other words, if the net cash flow is less than the net income, then the company is in serious trouble.

Further Reading

  • Agency costs of free cash flow, corporate finance, and takeovers – [PDF]
  • Evidence on the role of cash flow for investment – [PDF]
  • Investment-cash flow sensitivities are not valid measures of financing constraints – [PDF]
  • Do investment-cash flow sensitivities provide useful measures of financing constraints? – [PDF]
  • Ownership structure, cash flow, and capital investment: Evidence from East Asian economies before the financial crisis – [PDF]
  • Financial development and the cash flow sensitivity of cash – [PDF]
  • The impact of cash flow volatility on discretionary investment and the costs of debt and equity financing – [PDF]
  • R&D investment and internal finance: The cash flow effect – [PDF]
  • The incremental information content of cash-flow components – [PDF]
  • Investment-Cash Flow Sensitivity: Financial Constraints or Agency Costs?[J] – [PDF]