Cash flow is the transfer of cash or money in and out of a firm’s business. Cash flow analysis can decide the liquidity state of the firm. It also displays the amount of cash getting in and out of the firm.
Generally, these are either positive or negative. It is determined by taking the difference between the opening balance and closing balance. Opening balance is the cash balance at the onset of a period. On the other hand, closing balance is the cash balance at the end of that period. Positive difference shows that you have made more revenue in the that period. Contrarily, negative difference shows the loss of cash from the opening balance.
A firm’s financial statement include three main parts:
- Balance Sheet : This provides a one-time display of the company’s liabilities and assets.
- Income Statement : This states the profitability of business over a certain period.
- Cash Flow Statement : This displays the details of cash transactions. This statements vary from the other two as it reunites income statement and balance sheet. These statements help in identifying the source where the cash comes from or goes out. These statements contain three major categories. It is important to know each of them:
- Operating Cash Flow : This states daily transactions.
- Investing Cash Flow : This states the transactions related to expansion cause.
- Financing Cash Flow : This states the transactions related to the payments with stockholders.
Now, let us consider several uses of cashflow in the long run:
- In the discovery of a business value by calculating the net present value.
- For identifying the liquidity of a firm.
- In measuring the funding gap of a frim.
- To calculate the cash flow per share of a business.
- For identifying the IRR(Internal Rate of Return) of an investor from an investment.
- CF can also be used to refund the investment and its growth.
- This can help in funding dividend payments to the investors.
- CF can determine the cash flow yield of a business.
However, cashflow of a firm alone cannot help you in making a decision for investment. For that reason, the firm’s income statements along with balance sheets must be observed thoroughly. You must know the financial condition of that firm. In case, if the firm sell its assets to pay off debt, this will still be positive. But, this doesn’t improve the liquidity. Therefore, you can’t just rely on the cashflow to decide the state of a firm.