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Types Of Cash Flow

Grace Christos
  The term “cash flow” refers to the net amount of cash and cash equivalents being transferred in and out of a company. It is the increase or decrease in the amount of money or cash a business, institution, or individual generates or consumes in a given time period. 
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Cash received into the organization represents inflows, while money spent represents outflows. Understanding cash flow is very important because an organization’s ability to create value for shareholders is fundamentally determined by its ability to generate positive cash flows or, more specifically, to maximize long-term free cash flow. Positive cash flow indicates that a company’s liquid assets are increasing, enabling it to cover obligations, reinvest in its business, pay up debts, pay expenses, and provide a buffer against future financial challenges. Cash flow is used to calculate the: Net Present Value of an organization (determining the Internal Rate of Return an investor achieves for making an investment). Liquidity rate (evaluating how well a company can meet its short-term financial goals and responsibilities) Cash Flow Yield (measuring how much cash a business generates per share, relative to its share price, expressed as a percentage) Cash Flow Per Share ( Calculates the amount of cash gotten from operating activities divided by the number of shares outstanding). Types of Cash Flow There are several types of Cash Flow, therefore, it’s important to have a solid understanding of each of them so you can clarify which cash flow is being used at a particular time. Breaking down the different types of cash flows lets you easily see which activities are generating the most income and expenses for your business, and provides you with a more accurate view of your company’s financial state. In addition, with proper understanding of different types of cash flow, you can be guided properly to adjust your financial strategies or business plans accordingly.
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There are three major cash flow types that companies should track and analyze to determine the liquidity and solvency of the business and they are:
  1. Operating Cash flow– Operating Cash flow refers to  cash that is generated by a company’s core business activities asides investing. This means cash involved directly with the production and sale of goods from ordinary operations. The operating cash flow indicates whether or not a company has enough funds coming in to pay its bills or operating expenses. In other words, for an organization to be financially stable, there must be more operating cash inflows than cash outflows.
In addition, the operating cash flow indicates the level at which your core business activities are performing from an expense versus income perspective, so you can gauge performance independent of other types of financial activities that may cloud the overall picture.
  1. Investing Cash flow: This represents the cash that’s available after capital expenditures that is the amount of cash reinvestment back into the business.  In other words, investing cash flow shows the amount of cash generated or spent from various investment-related activities in a specific period. 
Investment related activities include long term or capital investments, purchases of speculative assets, market securities, or the sale of securities or assets. Therefore the amount of money either generated or spent on these things over a period is called investing cash flow.
  1. Financing Cash flow– The financing cash flow is used in financial modeling and valuation as it identifies how well the business is structured, its financial performance and strength from an ownership and investment perspective. This is done by evaluating the balance of money going out to owners and investors compared to money coming back in.
In addition, financing cash flow shows the net flows of cash that are used for financing activities such as transactions involving issuing debt, equity, and paying dividends. Cash flow from financing activities provide investors with insight into a company’s financial strength and how well a company’s capital structure is managed. In conclusion, understanding how money flows in and out of your business on a regular basis is essential to gauging its financial well-being. You can get a much clearer picture by creating a statement of cash flows and breaking out your expenses and income into these categories. Featured image source: FreshBooks
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