Cash Flow – Explained

Cash flow refers to the movement of money in and out of a business. It is a measure of the amount of cash a company generates or uses in a given period. Positive cash flow means that more money is coming in than going out, while negative cash flow means that more money is going out than coming in.

Cash flow is important because it helps a company to pay its bills, invest in new projects and equipment, and pay dividends to its shareholders. It is different from profits, which are the amount of money a company makes after deducting expenses from revenues. A company can have positive profits but negative cash flow if it is not collecting payments from its customers or has high expenses.

There are two main types of cash flow: operating cash flow and investing cash flow. Operating cash flow is the cash generated or used by a company’s main operations, such as sales and expenses. Investing cash flow is the cash generated or used by investing activities, such as buying or selling assets like property or equipment.

Analyzing a company’s cash flow is an important aspect of financial management and can help investors and analysts to assess a company’s financial health and potential for growth. A company with strong positive cash flow can reinvest in its operations, pay off debt, and return value to shareholders, while a company with negative cash flow may struggle to fund its operations and may need to raise capital through debt or equity financing.

Example of cash flow:

Let’s say you run a small lemonade stand business. In one week, you sell 100 cups of lemonade for $2 each, which generates $200 in revenue. However, you had to pay $50 to buy the lemons, sugar, and cups needed to make and serve the lemonade, and $30 for a table, chair, and decorations to make your stand more appealing to customers. You also paid $10 for a permit to sell on the street.

Therefore, your total expenses for the week were $90, and your net cash flow (cash in minus cash out) was $110 ($200 in revenue minus $90 in expenses). You can use this cash flow to pay yourself, buy more supplies to make more lemonade, or invest in a new stand location or advertising to increase sales.

If you have negative cash flow, such as if you had only sold 50 cups of lemonade for $100 in revenue, but had spent $150 on expenses, you would have a net cash flow of -$50, meaning you spent more money than you made. This negative cash flow would be a warning sign that your business is not generating enough revenue to cover its expenses and could be at risk of failure if the trend continues.