Cash Flow - Explained
What is Cash Flow?
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Table of ContentsWhat is Cash Flow?How does Cash Flow Work? Free Cash FlowAcademic Research for Cash Flow
What is Cash Flow?
Cash flow (CF) simply refers to the flow (inflow and outflow) of cash within the operations of an organization. Cash flow have different meanings attributed to it across businesses and organizations. The performance of a company is not a good measure of cash flow and vice versa. In accounting for example, cash flow refers to the amount of difference between an opening balance and a closing balance. If the closing balance is higher than the opening balance, it is called a positive cash flow. When used as a financial term, cash flow describes the amount of cash and currency that is made (generated) or consumed (spent) at a given period.
Back to: ACCOUNTING, TAX, & REPORTING
How does Cash Flow Work?
Cash flow to the inflow and outflow of money in a business. It describes the increase or decrease in the amount of money a business or an individual has. The net amount of cash and cash-equivalents that are transferred into and out of a business is the cash flow of the business. There are various types of cash flow such as Operating Cash Flow (OCF) which is generated from the core activities of operations of a business. In general, cash flow describes the real movement of cash in and out of a business or firm. The cash flow of a company is often captured when financial statements are to be made. In financial reporting, the assessment of inflow and outflow of cash, the timing of the movement and their unpredictability are core areas that are covered. The liquidity of a company is assessed based on the operating cash flow, financing and investing cash flow. Although, cash flow is not a good measure of a company's performance, the financial health of a company, is the ability to pay debts and future expenses is crucial. A company's liquid assets are said to be increasing if the company has a positive cash flow. However, it is possible for the company to take on debts or sell its long-term assets to have a positive cash flow but this is not good for the future growth of the company.
Free Cash Flow
Profitability in a business translates to the ability of a company to cater for production and sales expenses, settle debts, reinvest in its business, save for future uncertainties and return money to its shareholders. The profitability of a business can be better understood looking at the free cash flow (FCF) of the business. FCF is the cash available after a business might have paid dividends, debts and reinvested. It is the amount of money left after capital expenditures, dividends and operating cash flow are removed from the net amount of cash available in a business. The difference between the levered and unlevered free cash flow of a business indicates the financial health status of the business.
Academic Research for Cash Flow
- Agency costs of free cash flow, corporate finance, and takeovers, Jensen, M. C. (1986). The American economic review, 76(2), 323-329.
- The cash flow sensitivity of cash, Almeida, H., Campello, M., & Weisbach, M. S. (2004). The Journal of Finance, 59(4), 1777-1804.
- Do investment-cash flow sensitivities provide useful measures of financing constraints?, Kaplan, S. N., & Zingales, L. (1997). The quarterly journal of economics, 112(1), 169-215.
- Over-investment of free cash flow, Richardson, S. (2006). Over-investment of free cash flow. Review of accounting studies, 11(2-3), 159-189.
- Investment-cash flow sensitivities are not valid measures of financing constraints, Kaplan, S. N., & Zingales, L. (2000). The Quarterly Journal of Economics, 115(2), 707-712.
- Cash flow and investment: Evidence from internal capital markets, Lamont, O. (1997). The Journal of Finance, 52(1), 83-109.Evidence on the role of cash flow for investment, Gilchrist, S., & Himmelberg, C. P. (1995). Journal of monetary Economics, 36(3), 541-572.Free cash flow and stockholder gains in going private transactions, Lehn, K., & Poulsen, A. (1989). Free cash flow and stockholder gains in going private transactions. The Journal of Finance, 44(3), 771-787.Customer satisfaction, cash flow, and shareholder value, Gruca, T. S., & Rego, L. L. (2005). Journal of marketing, 69(3), 115-130.Do financing constraints explain why investment is correlated with cash flow?, Kaplan, S. N., & Zingales, L. (1995). National Bureau of economic research.