Cash flow / Net cash flow / Cumulative cash flow Encyclopedia of Business Terms and Methods, ISBN 978-1-929500-10-9.

Copyright 2011 by Marty J.Schmidt. The Meaning of Cash Flow Term cash flow refers literally to the "flow," or movement of cash funds into or out of a business. This entry defines cash flow related terms (e.g. net cash flow, cumulative cash flow), and illustrates the role of cash flow in financial statement analysis and business case analysis. The sum of incoming cash flows and outgoing cash flows oerr a specified period of time is called Net Cash Flow illustrates Net Cash Flow = Sum of inflows Sum of Outflows Over a given time period. Cash flow is distinguished from accounting terms related to income, such as "revenues," "expenses," and "costs" which do not necessarily represent real cash flow. Consider, for instance, a person paying a restaurant bill with a credit card (a charge card, not a bank debit card). That is a cost event, but not cash flow. Cash flow does not occur until the credit card bill is paid (funds flow out of the cardholder's bank account). Individuals and companies need to manage and control both costs and cash flow, and the two concepts are closely related, but they are not the same thing. This is because regulatory groups, standards boards, and tax authorities, allow or require companies to use conventions such as depreciation expense, allocated costs, and accrual accounting on the income statement. Actual cash flow gains and losses for the period are reported more directly on another reporting instrument, the Statement of Changes in Financial Position (or cash flow statement, or funds flow statement). The cash flow statement does not include some expense items found in the income statement, for instance, such as depreciation expense. Depreciation expense does not represent an actual cash payment during the reporting period, but rather an accounting charge against earnings. Cash flow and net cash flow are center stage in two kinds of business analysis. Financial Statement Analysis: Cash flow metrics are viewed as one measure of a company's financial positionespecially its ability to meet current obligations and take action on short notice. For more explanation and examples, see the encyclopedia entryCash flow statement, financial accounting.

Business Case and Investment Analysis: Cash flows are viewed as the basic input and output of a proposed action. Cash flow estimates support further analysis with financial metrics such as Net Present Value (NPV), Internal Rate of Return (IRR), Return on Investment (ROI), and Payback Period. For definition and examples of the business case cash flow statement, see the encyclopedia entry Cash flow statement, business case analysis.

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Cash Flow in Financial Statement Analysis In financial reporting, the Cash Flow Statement (usually called Statement of Changes in Financial Position) is one of four primary reporting instruments that publically traded companies publish quarterly and annually. The cash flow statement tells management and stockholders how much cash they have to work with and how much they gained or lost during the period. By contrast, the Income Statement (or Profit & Loss Statement, P&L) tells stockholders and taxing authorities what the company reports for earnings during a period. As mentioined, reported earnings and changes in cash position are related to each other, but they are not the same thing. The other two primary financial reporting statements are the Balance Sheet and Statement of Retained Earnings. "Cash on hand" also shows up under "Current Assets" on the Balance Sheet. The company's Net Cash flow for a given period is the difference between category sums for "Sources of Cash" and "Uses of Cash." The company's cash on hand, as well as net cash gains or losses, are major components of financial statement metrics such as working capital, The current ratio, and quick ratio. A low current ratio, for instance, can be a signal to management to investors that the company is not well prepared to meet payroll or other short term obligations. For examples illustrating the meaning and calculation of these metrics, see Financial Metrics Pro. [ Page Top ] [ Encyclopedia ] [ Business Case Books & Tools ] [ Home ]

Cash Flow in the Business Case and Investment Analysis In the simplest kind of investment analysis, there may be only two cash flow events: The original investment (outflow) and collection of the returns (inflow). This scenario describes an investor who buys a certain kind of bond and then simply holds it until maturity (or an investor who makes a winning bet on a racehorse). Investment metrics such as simple return on investment, yield, and present value are still possible with such transactions. In business, however, investments (or actions examined with business case analysis) typically bring a series of cash inflows and outflows over time. The resulting cash flow stream may look something like this:

When analysis forecasts a cash flow stream of this kind, management takes the analysis further with financial metrics designed to answer specific kinds of questions (metrics refers to measurement). How do returns compare to investment costs? How does this investment (or action) compare to other potential uses of the same investment funds? Which possible course of action is the better business decision? In this way, projected cash flow and its analysis lie at the heart of the financial business case. As an example, one business case scenario might line up the expected cash flow results for several time periods to create a cash flow stream. The action or acquisition under consideration is expected to bring a net cash flow of $100 over five years. But does this represent a good business decision? Can the returns be improved? Where are the risks? The level of detail in this table is the minimum data needed to begin answering such questions Business Case Results: Proposal Scpayback.htmlenario. Timing Now Year 1 Year 2 Year 3 Year 4 Year 5 Total Inflows $0 $40 $50 $75 $90 $100 $355 Outflows $100 $20 $30 $35 $30 $40 $225 Net CF $100 $20 $20 $40 $60 $60 $100

The action or acquisition under consideration is expected to bring a net cash flow of $100 over five years. But does this represent a good business decision? Can the returns be improved? Where are the risks? The level of detail in this table is the minimum data needed to begin answering such questions. Note that each column and row tells a story: Inflows continue to rise throughout the 5-year period, but so do total outflows. Management will want to use this understanding and the data behind it, for instance, to apply financial tactics: reduce costs, increase gains, accelerate

gains. In a nutshell, a business case summary should always include a projected net cash flow stream for each business case scenario, because it Shows actual inflow and outflow figures, which are important for budgeting and business planning.

Provides the basis for calculating other financial metrics, such as NPV, DCF, IRR, andpayback.

Is the beginning point for management actions to manage and optimize overall results.

More information on these topics is available on this site: For a brief overview of business case content and structure, see the Solution Matrix FAQ What's a Business Case, or click here to read the first chapter of Business Case Essentials.

For an introduction to the primary cash flow financial metrics, see the topics in this free online encyclopedia for Net Present Value (NPV), Internal Rate of Return, Return on Investment, and Payback Period. For a comparison of these metrics and what they say about the cash flow stream, see "What is the Best Way to Summarize a Business Case?"

For working examples, implementation guidance, and more in depth coverage of other cash flow metrics, see the spreadsheet tool Financial Metrics Pro.

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Graphing Net Cash Flow

It is usually helpful to show cash flow results as graphical images, as well as tabled data, even when the graph really contains no information that cannot be read from the table. The graph communicates a "feel" for the overall cash flow pattern and period to period trends that is not so easily grasped from the table. A net cash flow stream, such as the right column of the table above, is normally graphed as a series of simple vertical bars, like the example above or like the example at left for the tabled data.

When it is important to see the inflows and outflows that contribute to net cash flow, the analyst can show all data in the table in one graph, using a combination chart, such as the one at left.

Cumulative Net Cash Flow and Present Value It is often helpful to present net cash flow figures and graphs along with other metrics derived from these figures, including cumulative cash flow and present values for the cash flow stream. In this case, the net cash flow figures are used first to create additional data for graphing, as shown in the table below. This table starts with the Net Cash Flow (Net CF) column from the table above. Net Timing Now Year 1 Year 2 Year 3 Year 4 Year 5 Total CF $100 $20 $20 $40 $60 $60 $100 CF $100 $80 $60 $20 $40 $100 Cumulative Value $100.00 $18.52 $17.15 $31.75 $44.10 $40.84 NPV=$52.36 Present

Cumulative cash flow figures show the total net cash flow through the end of each period. The

cumulative value for Year 3, for instance, is the sum of the year's net cash flow plus the net cash flows for Years 2, 1, and the initial outflow: $40 + $20 + 20 $100 = $20.

Cumulative cash flow can be graphed either with a bar chart, or with a line chart, as the examples at left show. When a cumulative curve rises from negative to positive values over time, as this one does, the line chart can be used to show the Payback Period, that is, the length of time it takes for the investment returns to equal investment costs. For more on the computation and uses

of payback period as a financial metric, see the Encyclopedia entry Payback period. Note, incidentally, that the line chart shown here was made with Microsoft Excel's X-Y Scatter Plot Chart, not the Excel Line chart. Only the scatter plot places data points appropriately at each year end on the horizontal axis, thus locating the payback event correctly. When the cash flow figures are used for discounted cash flow analysis, the analyst can graph each net cash flow alongside its discounted result, that is, alongside its present value, as shown in the bottom graph. Each present value is the net cash flow (here, called future value), divided by (1+ i )n, where iis an interest rate (discount rate) and n is the number of interest periods (here, years). Using an 8% discount rate, the Year 3 present value of $31.75 results when the net cash flow, $40 is divided by (1 + 0.08)3 (That is, $40 divided by 1.26). For a complete overview and introduction to the calculation and use of present value and other time value of money concepts, see the Encyclopedia entry for Discounted cash flow. The World's Most Frequently Cited Business Case Book

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