What means cash flow? – Definition and example

Different areas that are related to cashflow

Cash is considered the soul of a business. Without cash, a business or even a trader cannot survive. Therefore, measuring how much cash goes in and out of business is vital. The term cash flow was coined for the same purpose. 

Traders can ascertain the net amount of cash moving in and out of the concern. Let us understand cash flow in more depth. 

What is cash flow?

Graphic showing cashflow

As mentioned, cash flow is the flow of net cash and other equivalent things in and out of the enterprise. 

If a trader receives dividends for his investment, it will represent an inflow of cash. Other examples of inflow include money from sales, royalties, debtors, interests, etc.

Contrarily, money spent on buying shares or anything will mean an outflow of cash. It usually consists of revenue and capital expenditure. 

In most financial reports, the main objective is to assess cash flow, its origination, and where it goes. Cash flow is important to know how a company performs financially and how better it can bear any financial instability. 

A business should have a positive cash flow to maintain its goodwill and attract investors. It means that the business has more inflow than outflow of cash.

A positive cash flow indicates:

  • The firm’s liquid assets are increasing.
  • It can repay loans taken from banks and creditors. 
  • It can cover all its expenses, pay the shareholders, and much more. 

Furthermore, a company with financial flexibility can withstand any challenges. Investors are also attracted to those companies that have a positive cash flow.

Analyzing cash flow with cash flow statements

Cashflow statement of a company

You need a cash flow statement to analyze any business’s liquidity and profitability. It is a formal financial statement describing the company’s source and use of cash during a particular time. 

Analysts and investors use a cash flow statement to determine a company’s ability to generate cash and cover its operating expenses. 

The company’s most vital financial statement is the cash flow statement. It is one of the crucial parts, in addition to the balance sheet and income statement. 

Cash flow example:

Here is an illustration of a company’s cash flow statement that will help you clarify the concept. 

Cash Flow from OperationsAmount
Net Income$60,000
Additions to Cash
Increase in Accounts Payable$10,000
Subtractions from Cash
Increase in Accounts Receivable $20,000
Increase in Inventory$30,000
Net Cash from Operations$40,000
Cash Flow from Investing
Purchase of Equipment$5,000
Cash Flow from Financing
Notes Payable$7,500
Cash Flow for Month Ended$42,500
  • The blue dollar amounts lead to an outflow of cash. For example, the increase in inventory suggests that the business added the inventory worth this amount to the balance sheet. However, we purchased the $30,000 inventory, reducing the cash. 
  • The amounts in black suggest an inflow of cash. For example, the income statement shows the $20,000 depreciation as an expense. However, it does not reduce any cash. That is why we add it back to the net income. 

From the table above, you can see that the cash flow statement has three parts. Each section has its significance in the business and leads to the inflow and outflow of cash.

The bottom line

Cash flow is vital for understanding how well a business works. Many people confuse it with profits, but they are not the same. Profits are the net income of a trader. Contrarily, cash flow is the net amount of cash going in and out of business. 

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