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Cash Flow: What It Is, How It Works, and How to Analyze It

What Is Cash Flow? Cash flow is the net cash and cash equivalents transferred in and out of a company. Cash received represents inflows, while money spent represents outflows. A company creates value for shareholders through its ability to generate positive cash flows and maximize long-term free cash flow (FCF). FCF is the cash from normal business operations after subtracting any money spent on capital expenditures (CapEx). KEY TAKEAWAYS • Cash flow is the movement of money in and out of a company. • Cash received signifies inflows, and cash spent is outflows. • The cash flow statement is a financial statement that reports a company’s sources and use of cash over time.1 • A company’s cash flow can be categorized as cash flows from operations, investing, and financing.1Investopedia / NoNo Flores

Understanding Cash Flow Businesses take in money from sales as revenues and spend money on expenses. They may also receive income from interest, investments, royalties, and licensing agreements and sell products on credit. Assessing cash flows is essential for evaluating a company’s liquidity, flexibility, and overall financial performance. Positive cash flow indicates that a company’s liquid assets are increasing, enabling it to cover obligations, reinvest in its business, return money to shareholders, pay expenses, and provide a buffer against future financial challenges. Companies with strong financial flexibility fare better in a downturn by avoiding the costs of financial distress. Cash flows are analyzed using the cash flow statement, a standard financial statement that reports a company’s cash source and use over a specified period. Corporate management, analysts, and investors use it to determine how well a company earns to pay its debts and manage its operating expenses. The cash flow statement is an important financial statement issued by a company, along with the balance sheet and income statement.1  Net Cash Flow = Total Cash Inflows – Total Cash Outflows

Cash Flow Statement The cash flow statement acts as a corporate checkbook to reconcile a company’s balance sheet and income statement.1 The cash flow statement includes the “bottom line,” recorded as the net increase/decrease in cash and cash equivalents (CCE). The bottom line reports the overall change in the company’s cash and its equivalents over the last period. The difference between the current CCE and that of the previous year or the previous quarter should have the same number as the number at the bottom of the statement of cash flows.1 Below is Walmart’s cash flow statement for the fiscal year ending on Jan. 31, 2019. All amounts are in millions of U.S. dollars.2Investments in property, plant, and equipment (PP&E) and acquisitions of other businesses are accounted for in the cash flow from the investing activities section. Proceeds from issuing long-term debt, debt repayments, and dividends paid out are accounted for in the cash flow from the financing activities section. Walmart’s cash flow was positive, showing an increase of $742 million, which indicates that it has retained cash in the business and added to its reserves to handle short-term liabilities and fluctuations in the future.Walmart Statement of Cash Flows (2019)Cash flows from operating activities: Consolidated net income7,179(Income) loss from discontinued operations, net of income taxes—Income from continuing operations7,179Adjustments to reconcile consolidated net income to net cash provided by operating activities: Unrealized (gains) and losses3,516(Gains) and losses for disposal of business operations4,850Depreciation and amortization10,678Deferred income taxes(499)Other operating activities1,734Changes in certain assets and liabilities: Receivables, net(368)Inventories(1,311)Accounts payable1,831Accrued liabilities183Accrued income taxes(40)Net cash provided by operating activities27,753  Cash flows from investing activities: Payments for property and equipment(10,344)Proceeds from the disposal of property and equipment519Proceeds from the disposal of certain operations876Payments for business acquisitions, net of cash acquired(14,656)Other investing activities(431)Net cash used in investing activities(24,036)  Cash flows from financing activities: Net change in short-term borrowings(53)Proceeds from issuance of long-term debt15,872Payments of long-term debt(3,784)Dividends paid(6,102)Purchase of company stock(7,410)Dividends paid to noncontrolling interest(431)Other financing activities(629)Net cash used in financing activities(2,537)  Effect of exchange rates on cash and cash equivalents(438)  Net increase (decrease) in cash and cash equivalents742Cash and cash equivalents at beginning of year7,014Cash and cash equivalents at end of year7,756

Types of Cash Flow Cash Flows From Operations (CFO) Cash flow from operations (CFO), or operating cash flow, describes money flows involved directly with the production and sale of goods from ordinary operations. CFO indicates whether or not a company has enough funds coming in to pay its bills or operating expenses. Operating cash flow is calculated by taking cash received from sales and subtracting operating expenses that were paid in cash for the period. Operating cash flow is recorded on a company’s cash flow statement, indicates whether a company can generate enough cash flow to maintain and expand operations, and shows when a company may need external financing for capital expansion.3 Cash Flows From Investing (CFI) Cash flow from investing (CFI) or investing cash flow reports how much cash has been generated or spent from various investment-related activities in a specific period. Investing activities include purchases of speculative assets, investments in securities, or sales of securities or assets. Negative cash flow from investing activities might be due to significant amounts of cash being invested in the company, such as research and development (R&D), and is not always a warning sign.1 Cash Flows From Financing (CFF) Cash flows from financing (CFF), or financing cash flow, shows the net flows of cash used to fund the company and its capital. Financing activities include transactions involving issuing debt, equity, and paying dividends. Cash flow from financing activities provides investors insight into a company’s financial strength and how well its capital structure is managed.1

How to Analyze Cash Flows Using the cash flow statement in conjunction with other financial statements can help analysts and investors arrive at various metrics and ratios used to make informed decisions and recommendations. • Free Cash Flow: FCF is a measure of financial performance and shows what money the company has left over to expand the business or return to shareholders after paying dividends, buying back stock, or paying off debt.3 • Unlevered Free Cash Flow: UFCF measures the gross FCF generated by a firm that excludes interest payments, and shows how much cash is available to the firm before financial obligations.3 • Operating Cash Flow: OCF is money generated by a company’s primary business operation. • Cash Flow to Net Income Ratio: The ratio of a firm’s net cash flow and net income with an optimum goal of 1:1. • Current Liability Coverage Ratio: This ratio determines the company’s ability to pay off its current liabilities with the cash flow from operations. • Price to Money Flow Ratio: The operating money flow per share is divided by the stock price. How Are Cash Flows Different Than Revenues? Revenue is the income earned from selling goods and services. If an item is sold on credit or via a subscription payment plan, money may not yet be received from those sales and are booked as accounts receivable. These do not represent actual cash flows into the company at the time. Cash flows also track outflows and inflows and categorize them by the source or use. What Is the Difference Between Cash Flow and Profit? Cash flow isn’t the same as profit. Profit is specifically used to measure a company’s financial success or how much money it makes overall. This is the amount of money that is left after a company pays off all its obligations. Profit is found by subtracting a company’s expenses from its revenues.1 What Is Free Cash Flow and Why Is It Important? Free cash flow is left over after a company pays for its operating expenses and CapEx. It is the remaining money after items like payroll, rent, and taxes. Companies are free to use FCF as they please. Do Companies Need to Report a Cash Flow Statement? The cash flow statement complements the balance sheet and income statement and is part of a public company’s financial reporting requirements since 1987.2 Why Is the Price-to-Cash Flows Ratio Used? The price-to-cash flow (P/CF) ratio is a stock multiple that measures the value of a stock’s price relative to its operating cash flow per share. This ratio uses operating cash flow, which adds back non-cash expenses such as depreciation and amortization to net income. P/CF is especially useful for valuing stocks with positive cash flow but are not profitable because of large non-cash charges.

The Bottom Line Cash flow refers to money that goes in and out. Companies with a positive cash flow have more money coming in, while a negative cash flow indicates higher spending. Net cash flow equals the total cash inflows minus the total cash outflows.