Cash flow

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Cash flow is the movement of cash into or out of a business, project, or financial product. (Note that the word cash is used here in the broader sense, where it includes bank deposits.) It is usually measured during a specified, finite period of time. Measurement of cash flow can be used for calculating other parameters that give information on the companies' value and situation. Cash flow can e.g. be used for calculating parameters:

  • to determine a project's rate of return or value. The time of cash flows into and out of projects are used as inputs in financial models such as internal rate of return, and net present value.
  • to determine problems with a business's liquidity. Being profitable does not necessarily mean being liquid. A company can fail because of a shortage of cash, even while profitable.
  • as an alternate measure of a business's profits when it is believed that accrual accounting concepts do not represent economic realities. For example, a company may be notionally profitable but generating little operational cash (as may be the case for a company that barters its products rather than selling for cash). In such a case, the company may be deriving additional operating cash by issuing shares, or raising additional debt finance.
  • cash flow can be used to evaluate the 'quality' of Income generated by accrual accounting. When Net Income is composed of large non-cash items it is considered low quality.
  • to evaluate the risks within a financial product, e.g. matching cash requirements, evaluating default risk, re-investment requirements, etc.

Cash flow is a generic term used differently depending on the context. It may be defined by users for their own purposes. It can refer to actual past flows, or to projected future flows. It can refer to the total of all the flows involved or to only a subset of those flows. Subset terms include 'net cash flow', operating cash flow and free cash flow.

Contents

Statement of cash flow in a business's financials

The (total) net cash flow of a company over a period (typically a quarter or a full year) is equal to the change in cash balance over this period: positive if the cash balance increases (more cash becomes available), negative if the cash balance decreases. The total net cash flow is the sum of cash flows that are classified in three areas:

Ways Companies Can Augment Reported Cash Flow

Common methods include:

  • Sales - Sell the receivables to a factor for instant cash. (leading)
  • Inventory - Don't pay your suppliers for an additional few weeks at period end. (lagging)
  • Sales Commissions - Management can form a separate (but unrelated) company and act as its agent. The book of business can then be purchased quarterly as an investment.
  • Wages - Remunerate with stock options.
  • Maintenance - Contract with the predecessor company that you prepay five years worth for them to continue doing the work
  • Equipment Leases - Buy it
  • Rent - Buy the property (sale and lease back, for example).
  • Oil Exploration costs - Replace reserves by buying another company's.
  • Research & Development - Wait for the product to be proven by a start-up lab; then buy the lab.
  • Consulting Fees - Pay in shares from treasury since usually to related parties
  • Interest - Issue convertible debt where the conversion rate changes with the unpaid interest.
  • Taxes - Buy shelf companies with TaxLossCarryForward's. Or gussy up the purchase by buying a lab or O&G explore co. with the same TLCF.[1]

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