Business owners usually can’t manage what they can’t measure. That is why to know the movement of the cash in your company you must be able to measure it. This can be possible through a financial metric called cash flow.
What is a cash flow?
The cash flow is a financial metric that shows the cash and cash equivalents (CCE) that move in and out of the company. CCE is the financial assets that the business could convert into cash.
To know the profitability of the company it’s important to understand the differences between profit and cash flow. These terms can inform business owners of the best way to pursue growth by making important decisions.
How is used?
Cash flow shows how well you’re using your money. This includes all sources and uses of cash from business activities that are important to the company’s finances. A cash flow analysis can show whether the company can pay its bills and whether it has enough cash to carry out operations in the future.
For example, the seasonal business can experience significant cash inflows during peak season and cash outflows during off-peak times. It’s important for businesses to better manage their finances, ensuring that they have enough cash reserves during their off-peak seasons.
Cash flow can be positive and negative. Positive cash flow means that more cash is moving in than spending out. Negative cash flow means that more money is moving out than coming in.
What are the different types?
Cash flow activities are classified into three categories:
- Operating – Operating activities are the revenues and expenses incurred by the company’s core business operations. It’s important to remember that in order to sustain business growth in actively growing companies is to have a positive cash flow.
- Investing – Investing activities are all net cash made by the company’s investing activities. In healthy companies that invest frequently, the number can be negative.
- Financing – Financing activities refer to the moving of the cash between the investor, owner, or creditor and the company. This is the net cash made to finance the company and may include debt, equity, and dividend payments.
Now that you know the three types of cash flow activities, a company can determine its free cash flow.
What is free cash flow?
The free cash flow represents the true amount of cash that the business has available and can use.
This is the net amount of the cash after operating all expenses, taxes, reinvestments, etc.
Here is a formula for how to calculate it:
Free Cash Flow = Cash Flow from Operations – Capital Expenditures
This is a metric that indicates the company’s financial health in its truest form.
