Cash Flow

Cash Flow describes the process of cash coming in and cash going out of a business.

Imagine you bought a computer from a friend for $250 that you will pay at the end of the week.  You turn around and sell the computer to a friend for $400 that they will pay at the end of the week.  At the end of the week you will receive $400 and have to give out $250, keeping $150.  The end of the week comes by, and your friend says they did not get the $400 yet and they will be able to pay you at the end of the next week, you now will receive nothing and have to pay out $250.

You have bad cash flow problems.  This actually happens allot with companies where payment for goods is given after turning over the inventory.  This is where we get the terms of payment in 2 weeks, 30 days or any other period.  If you were a company, you would either default on the loan, go bankrupt or take on a new loan with favorable terms.

Cash Flows Does Not Mean Sales

A business can increase sales and profits but still have bad cash flow problems.  Imagine a car dealership where most of the cars have been purchased by customers on credit, the dealership will have on paper increased sales and high cash receivable but delivery fees, new inventory costs, payroll, and taxes could cause bad cash flow problems if any cash payable agreement comes payable immediately.   This also makes a hard time for accountants because they have to report these cash flow problems and having that on record can scare away potential financiers.

The biggest cash flow problem occurs either when cash is coming in at a later time than it is needed to pay current expenses.  This can cause a firm to bankruptcy if the problem persists and is not solved.

Measuring Cash Flow

The relationship between a business and its lenders is crucial, and the lender should be able to deal with terms that the business can handle.  The role of a Chief Financial Officer is to accurately forecast and manage funds, which is vital to a firm that can operate and have good cash flow.  This problem can be knowing how much you need to operate and making sure you have a surplus of funds before you start.

The Statement of Cash Flows reports cash receipts and cash disbursements to three major areas; Operations, Investments, and Financing.  It helps analyze all changes in a firms financial position and keeps tract of operating expenses (where cash is needed to pay operating costs), and funds raising from financing.

• Operating expenses from sales commissions, fees, interest, dividends, cash, salaries, inventories, expenses, interest on loans, and taxes.
• Investments including a purchase or sale of long term assets, purchase of equity, and lending activities.
• Financing includes the firm’s equity sales and purchases and borrowing activities.

Financial Performance can be analyzed by using ratios of relevant metrics.  The ratios are used to determine Leverage, Liquidity, Profitability, Turnover, and other Activity ratios.  The metrics are taken from accounting statements at year ends.

Cash Flow Analysis on the basic level goes over auditing, managing taxes, advising top management on financial matters, credit management, funds management, obtaining, controlling, collecting funds, budgeting, and management level planning.

A Cash flow forecast predicts future cash receivable and cash payable in reoccurring periods.  This can only be done with well researched estimates of costs, and realistic estimates of sales within the budget.

Check out this free PDF Cash Flow Outline, that briefly explains the basic components of a Cash Flow Statement.