Cash flow

Key takeaways

Measures the inflow and outflow of cash in a business

Critical for assessing a company's financial health and liquidity

Divided into operating, investing, and financing activities

Positive cash flow indicates more money coming in than going out

Essential for day-to-day operations and long-term financial planning

Cash flow is a fundamental concept in business finance, providing insight into a company's ability to generate cash to pay debts, fund operations, and invest in growth. It's typically analysed through the cash flow statement, which breaks down cash movements into three main categories:

Operating activities: Cash generated or used in core business operations.
Investing activities: Cash used for investing in assets or received from selling assets.
Financing activities: Cash from issuing stock or debt, or payments for dividends and debt repayment.

Understanding cash flow is crucial because:

It indicates a company's ability to pay bills and fund growth
It can differ significantly from profit, as profit includes non-cash items
It helps in assessing the quality of a company's earnings
It's essential for budgeting and financial forecasting

Positive cash flow generally indicates good financial health, while negative cash flow may signal potential liquidity issues. However, context is essential - a company might have negative cash flow due to significant investments in future growth.

Real-world examples

Case study: Apple's Cash Flow Management

In 2022, Apple reported operating cash flow of $122 billion. This strong cash generation allowed Apple to invest in research and development, make strategic acquisitions, and return value to shareholders through dividends and share buybacks.

Case study: Tesla's Cash Flow Turnaround

Tesla struggled with negative cash flow in its early years as it invested heavily in production capacity. However, by 2020, Tesla achieved positive free cash flow, demonstrating its transition to a more financially stable position.

Frequently asked questions about cash flow

1) Why is cash flow important if a company is profitable?

Profit doesn't always equate to cash availability. A company can be profitable on paper but still face cash shortages due to timing of payments or non-cash expenses.

2) How does depreciation affect cash flow?

Depreciation is a non-cash expense that reduces profit but not cash flow. It's added back when calculating cash flow from operating activities.

3) Can a company have positive cash flow but negative profits?

Yes, this can occur if a company has significant non-cash expenses or if it's receiving cash from sources not reflected in the income statement.

4) How often should a business analyse its cash flow?

Regular analysis is crucial. Many businesses review cash flow monthly, but some may need to do it more frequently, especially in times of financial stress.

5) What's the difference between direct and indirect cash flow methods?

The direct method lists actual cash inflows and outflows, while the indirect method starts with net income and adjusts for non-cash transactions and changes in balance sheet accounts.