What is Cash Flow? 

The term "cash flow" basically means the flow of money in and out of business. The cash flow usually takes place from operational, investing, and financing activities. The cash flow normally denotes the amount of cash that is transferred either into the business as positive cash flows or out of business as expenses with regards to operating, investing, and financing activities. 

Types of Cash Flows 

There are three types of cash flows that form part of the cash flow statement: 

i. Operating Cash Flow:

 The operating cash flow is the first section of the cash flow statement, which helps in measuring how much cash has been generated by the company's business activities. It helps in analyzing whether a company can generate enough positive cash flows to manage its operations efficiently and effectively. There are generally two methods that are used for depicting cash flow on a cash flow statement under the Generally Accepted Accounting Principles (GAAP): 

   a. Indirect Method: Indirect method of ascertaining cash flow from operating activities usually begins with the amount of net income or net loss because the income statement shows the effect of all the operating activities on an enterprise. However, it is prepared on an accrual basis (and not on a cash basis) and also includes certain non-operating items such as interest paid, profit, or loss on sale of fixed assets, etc.) and non-cash items (such as depreciation). Therefore, it becomes necessary to adjust the amount of net income or loss as shown by the income statement for arriving at cash flows from operating activities. 

   b. Direct Method: In this method, all the cash basis transactions that have taken place in a particular period are tracked down, and thereafter cash inflows and cash outflows are adjusted accordingly on the cash flow statement. 

ii. Investing cash flow:

 The investing cash flow is the second section of the cash flow statement, which helps in identifying how much of the cash has been generated or spent on activities related to investment in a specific period. The investing activities include the purchase of physical assets, investment done insecurities, etc. The negative cash flow in the case of investing activities does not indicate poor performance of the company, and rather it is indicative of the company's large investment in research and development, wrong decisions made with regards to purchase of assets, or any expenses incurred for the growth of the company. 

iii. Financing Cash Flow: 

The financing cash flow is the final section of the cash flow statement. It is generally a form of financing in which a company takes a loan that is backed by the cash flows that the company expects to make. This form of cash flow helps the company to generate a considerable amount of cash from the sales, but since there is an insufficiency of physical assets that can be used as collateral for the loan which the company takes, the company gets involved in financing activities. The banks and other creditors extend loans to a company after effectively analyzing its positive cash flows. The cash flow loans can either be short-term or long-term. 

What is a Cash-Flow Statement? 

A cash flow statement is a financial statement that depicts a summary of the amount of cash or cash equivalents that inflows or outflows the company during a specific period. The cash flow statement is an important part of the company's financial reporting, along with the balance sheet and income statement. The cash flow statement helps in identifying the source from where the cash has originated and its use. It also helps in predicting the future cash flows for the company.

The cash flow statements prove to be very handy in providing information on a firm's solvency and liquidity and whether it will be able to change cash flows shortly if the need arises. 

Advantages of Cash Flow Statements

• It helps in knowing the liquidity and actual cash position of the company, which the income statements fail to identify. 
• The cash flow statement helps in overcoming any shortfalls which may be evident from the financial statements of the company. 
• The cash flow analysis, together with ratio analysis, helps in measuring the profitability and true financial position of the company. 
• The cash flow statement helps the organization to draw up a financial plan, thereby helping in its internal finance management. 

Disadvantages of Cash Flow Statement 

• The cash flow statement alone shows only the cash position of the company, and it requires the usage of balance sheets and other financial statements to project the true income statement of the company. Therefore, the cash flow statement can never be substituted for an income statement. 
• The cash balance as depicted by the statement may sometimes show incorrect values as it can be manipulated easily with postponed payments and purchases. 

What is Free Cash Flow, and why is it Important? 

The free cash flow is the amount of cash that is left over after the company has paid for its operating and capital expenses. In comparison to the net income or earnings, the free cash flow excludes non-cash expenses of the income statement and includes the expenditures on equipment and assets. The free cash flow also helps the potential shareholders to evaluate how quickly the company can pay interest and dividends. 

What is Cash Outflow? 

The money that goes out of the company is referred to as cash outflows. The position of the business is considered unhealthy when there is more outflow of cash than inflow.  The cash outflow generally includes payments to business partners, employees, creditors, etc. The outflow also occurs when long-term assets are usually purchased, investments are acquired, or certain expenses about the business are incurred. 

What is Cash Inflow? 

The cash inflow refers to the transfer of funds into a company by any third party, which might likely happen due to any operational, investing, and financing activities. The cash inflow includes payments made by customers or investments made by the investors into the company by purchasing its equity. 

Common Mistakes 

The care must be taken while calculating the cash flows, and the expenses from investing, financing, and operational activities are to be populated accordingly. The investing expenses should not be populated under the head cash flow from operating or financing activities so on and so forth. 

Context and Applications 

This topic is significant in the professional exams for both undergraduate and postgraduate courses, especially for: 

• B.com (Honors) 
• M.com 
• Chartered Accountants (CA) 
• Company Secretary (CS) 
• MBA (Finance) 
• CMA (Certified Management Accountant) 

Related Concepts 

• Outbound Cash Flow. 
• Financial Statement Analysis. 
• Non-operating cash flow. 
• Corporate Cash Flow.