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Published: Nov 10, 2022 13 min read

Cash Flow


Cash is constantly moving into and out of businesses. Cash flow is the term used to describe the movement of this cash during a specific period.

While cash flow is a great indicator of the amount of money a person or business has, understanding this term in more detail is often critical in helping to make crucial decisions regarding a company's overall financial well-being.

What is a cash flow analysis?

A cash flow analysis is used to determine a company's working capital, or the amount of money available to run business operations and complete transactions.

When performing a cash flow analysis, companies need to analyze and track three types of cash flows: the cash flow from operating activities, investing activities and financing activities. This will allow them to see where their money is going, which can help them figure out the current state of their business.

Different types of cash flow

As mentioned above, to have a good understanding of how well your company is doing, you should have a thorough grasp of the three different types of cash flow.

Operating cash flow

Operating cash flow refers to the cash generated by a business's everyday operations and activities. To maintain growth and expansion, companies must have a positive operating cash flow.

Investment cash flow

Investment cash flow refers to the cash generated from investment activities that the business took part in. For example, purchasing securities to be held onto as investments — bonds, stocks or treasuries —, or purchasing physical assets like property and equipment.
For businesses actively investing in their company and doing it correctly, their investment cash flow will be negative.

Financing cash flow

Financing cash flow refers to how cash moves between investors, owners, creditors and a business. Basically, it is the cash that is generated to finance the company and includes the costs of raising capital, dividend payments and debt.

Why is cash flow important to a business?

Cash flow has various uses when it comes to operating a business. It allows you to meet your existing goals, figure out how well you are performing financially and plan for the future.

Today, there are several cash metrics that are important to keep track of. These financial indicators help show if a company is performing effectively and allows investors to compare companies to each other.

Some of the most common types of cash flow metrics include:


These metrics assess how well a business can meet its short-term financial obligations.

Internal rate of return

The internal rate of return (IRR) is a metric used to estimate a potential investment’s profitability.

Net present value

The net present value (NPV) is used in investment planning to analyze the profitability of a project or investment by calculating the difference between the present value of cash inflows and the current value of cash outflows over a specific period.

Cash flow per share

Cash flow per share refers to the after-tax earnings, including depreciation on a per-share basis, that measure the firm's financial strength. This figure is calculated by taking the cash from operating activities and dividing it by the number of outstanding shares. Most analysts agree that more emphasis should be put on this figure than earnings per share.

Cash conversion ratio

A cash flow conversion ratio measures how well a company converts its income into cash. This calculation divides operating cash flow by net income, and a good ratio often has this number at one or above.

Funding gap

A funding gap is the money required to fund a company's current operations and future developments that are not financed with equity, debt or cash. Instead, these gaps are usually funded by loans, investments from venture capital, debt offerings or equity sales.

Capital expenditures

Capitalexpenditures are the money the organization spends to maintain, buy or improve its fixed assets, including its buildings, vehicles or land.

What is a cash flow statement?

A cash flow statement is an important tool to manage a company's finances by tracking the organization's cash flow. This financial document is designed to help provide a detailed analysis of what happens to a company's cash during a specific period, making it useful for short-term planning.

  • This statement can also:
  • Show the source of the money coming in
  • Monitor outgoing funds
  • Inform about cash outflows, as well as fees paid for business activities and other investments at a specific point in time
  • Help maintain an optimum level of cash on hand
  • Help companies focus on generating cash

Consequently, management can use the cash flow statement to make better and more informed decisions regarding their business operations and the changes they need to make.

How do you prepare a cash flow statement?

A cash flow statement will include three sections, the cash flow from operating activities, the cash flow from investing activities and the cash flow from financing activities.

As a result, if you are trying to prepare a cash flow statement, you will need to follow the below steps.

Step one: Determine the beginning balance

The first thing you need to do to prepare your cash flow statement is to determine the starting balance of the cash and cash equivalents at the beginning of the reporting period. This value is found on the income statement. It should also be noted that this balance is necessary when trying to leverage the indirect method of calculating cash flow from operating activities, but it’s not required in the direct method.

Step two: Figure out the cash flow from operating activities

After you have the starting balance, you need to calculate the cash flow from operating activities. This number will reveal how much cash your business produced from its operations.
Cash flow from operating activities can be calculated by using either the direct or indirect method.

  • The direct method: This method takes all the cash collections from operations and subtracts the cash disbursements from the operational activities to get the net income.
  • The indirect method: Under this method, you will start with the net income from the income statement and adjust it to undo the impact of the accruals made during the reporting period. Essentially, this method requires you to add or subtract the non-cash revenue and expense items you have from the net income to calculate the implied cash flow.

Although both methods will have the same result, the process of calculating each will differ. Even though the direct method may seem easier to understand, it is often more time-consuming because it requires you to account for every type of transaction that took place during your reporting window.

Step three: Determine the cash flow from investing activities

Once you finish calculating the cash flow from operating activities, you will have to determine the cash flow from your investing activities. This section will detail cash flow related to the buying and selling of long-term assets, such as equipment or property.

Step four: Calculate the cash flow from financing activity

Next, you will have to examine the cash outflows and inflows related to your financing activities. This includes cash flow from both debt and equity financing.

Step five: Figure out the ending balance

Once you have calculated the above three cash flows, you will now be able to figure out the ending balance of cash and cash equivalents at the close of the reporting window. To do this, you will have to add all the cash flows from all the activities. From there, you will get a value showing you the total amount of cash your company lost or gained during the reporting period.

A positive value means the company has more cash coming in than going out, while a negative value indicates that the company is spending more than it is earning.

Cash flow and profit

The main difference between cash flow and profit

When it comes down to it, the main difference between cash flow and profit is that, while cash flow refers to the net flow of cash coming in and out of a business, profit indicates how much money a company has after all the expenses have been paid and taken care of.

Is cash flow more important than profit?

While both metrics provide meaningful information for business owners and investors, when a company is trying to find a single figure to determine how well their company is doing, these two terms often compete against each other. However, the answer to which of these metrics is more important is not straightforward.

In truth, whether you are a business owner or an investor, you should have a good understanding of both terms and what they mean. It would also be helpful to know how they interact with each other and what the terms can mean for your business.

For instance, if you are a startup, you may have a positive cash flow, but you could also have failed to make a profit for the year. As a result, if you focus on only one of these metrics, you will miss out on the whole picture of how your company is operating.

What is free cash flow?

Free cash flow (FCF) are the funds that remain after a business pays to support its operations and maintain its capital assets. Unlike net income or earnings, which is used to measure a company's profitability, free cash flow will usually provide better insight into a company's financial health, as well as its business model.
Additionally, investment bankers and financial analysts will use variations of free cash flow to determine a company's future performance with different capital structures.

Types of free cash flow

There are several different types of free cash flow. The ones that are most frequently used include:

Free cash flow to the firm

Also referred to as "unlevered," free cash flow to the firm (FCFF) represents the amount of cash flow from business operations available for distribution after accounting for taxes, depreciation costs, investments and working capital.

In essence, FCFF is the measure of a company's profitability and represents the available cash flow to a business if it was debt-free.

Free cash flow to equity

Free cash flow to equity (FCFE), also known as "levered," is the amount of money a business can make that is also available to be distributed to its shareholders. This amount is calculated by taking the cash from operations and subtracting it from capital expenditures plus the net debt issued.

The benefits of free cash flow

FCF gives companies, managers and investors an important insight into the financial health of a business and its overall value. When you have a large amount of FCF, it can mean that you will have enough funds to pay back your expenses with some money left over. This leftover can be used to reinvest in your business and pay investors or buy back stocks.

It is often observed that companies with high FCF figures are doing well and may want to expand. That is why investors are attracted to businesses with rising free cash flow because they are more able to produce a rate of return.

In comparison a business with low FCF can mean that there is little money left for them after they pay out their expenses and costs. Consequently, investors are usually not attracted to these types of businesses as their future earnings prospects are often low.

Key takeaways from Money's guide to cash flow

If your company is looking for metrics to help it determine how well it is doing financially, analyzing the cash flow is a great way to keep track of key data that can help you plan for your future while ensuring you have enough cash to help get you through some rainy days.