Cash flow and the planning and calculation of cash flow are essential components of successful corporate management. However, this key figure not only plays an important role in accounting and the success of a company, but also for investors and banks in order to obtain a picture of the company's state of health.
In this article, you will learn how to define cash flow, what different types of cash flow there are and which formulas you can use to calculate cash flow.
Cash flow compares incoming and outgoing payments within a given period of time. It serves as an indicator of a company's financial strength. A positive cash flow shows that more money is coming in than going out, which has a positive effect on the company's liquidity and financial stability.
Cash flow plays an important role in business management as a financial indicator. This is because the surplus generated by a company can be determined by comparing income and expenditure.
Cash flow is therefore required for balance sheet analysis, company valuation, financial planning, investment appraisal and accounting. It shows how many liquid funds a company has at its disposal. From this, it can be concluded to what extent investments can be financed from own funds.
It is important to note that the accounting period considered for cash flow is defined by the company itself - this is usually the previous financial year.
Cash flow therefore shows how much money flows in and out of a company during a self-defined period of time.
A distinction is made between three types of cash flow. The three categories reflect the different sources and uses of a company's funds.
Each of these categories provides specific insights into different aspects of a company's financial performance. In this way, they help to assess the financial position and the ability to finance future growth:
Operating cash flow refers to the cash flow generated by a company's main business activities. Accordingly, operating cash flow considers the income and expenses that are directly related to the company's core business.
This type of cash flow includes, for example, the following income and expenses:
As a result, operating cash flow is an important indicator of a company's financial performance in its day-to-day business operations. It makes it clear whether a company can finance itself. The goal of the company should therefore always be to achieve a positive operating cash flow.
Operating cash flow is also commonly referred to as ‘gross cash flow’, as it takes into account the funds generated during a previously defined period, but excludes expenses such as tax payments and private withdrawals. In order to determine the net cash flow, these expenses must therefore be deducted from the gross cash flow.
Investment cash flow refers to the cash flow generated or utilised by investments in non-current assets. In principle, investments can be made when a positive operating cash flow has been generated.
The investment cash flow includes, among other things
A negative investment cash flow therefore shows that a company has spent more money on non-current assets than it has received from the amortisation or sale of these assets.
Financing cash flow, on the other hand, is the cash flow generated by a company's financing activities.
These include, for example:
The financing cash flow therefore provides a good insight into how a company procures and utilises its capital. If the operating cash flow is negative but you still want to make investments, these can also be financed from this cash flow - for example by taking out a loan.
A company's cash flow is influenced by various factors, such as:
All of these factors are interlinked and can have both a negative and a positive impact on a company's cash flow. Balanced management of all factors is therefore necessary to ensure a stable cash flow.
Cash flow can be calculated in two ways: using the direct method and the indirect method. Depending on the circumstances and the availability of the required data, one method may be preferable to the other.
The direct method of calculating the cash flow is characterised by its simplicity. It is usually used by the company itself, as it allows the cash flow to be calculated very quickly and easily.
However, one argument against this method is that the calculation is based on internal information that cannot be verified by outsiders. As a rule, banks and investors do not have access to the data required for the direct method.
In addition, the direct method also includes income and expenses such as depreciation and receivables, which in reality do not flow into or out of the company as direct funds.
The direct method, which is part of internal accounting, is therefore used less frequently than the indirect method.
Cash flow is calculated directly using the following formula:
Cash inflows include, for example:
Cash expenses include the following items, for example:
The use of the indirect method is recommended if there is no reliable, internal information on cash inflows and outflows and you therefore have to rely on external, public sources.
As a rule, the indirect calculation is used if you want to calculate a company's liquidity situation on the basis of its annual financial statements. This is because outsiders do not have access to data on individual incoming and outgoing payments, but only to public data from the income statement and balance sheet.
All non-cash items are deducted from the net profit for the year.
The cash flow can therefore be calculated indirectly using the following formula:
‘Non-cash’ means that there has been no direct cash outflow or inflow, for example by means of a bank transfer. Nevertheless, the profit was reduced by the expenses and increased by the income.
Since the cash flow, as the name suggests, only refers to the amounts for which funds have actually flowed and not the amounts that have merely been reallocated, these must be deducted when calculating the cash flow.
Non-cash expenses include, for example:
Non-cash income includes, for example:
There is no direct cash flow for all these expenses and income, as the money was already in the company and has now merely been reallocated.
A company's cash flow is a key instrument for assessing liquidity. Finally, it shows how much money flows into a company and how much flows out.
The cash flow can therefore be positive or negative:
A positive cash flow means that a company earns more money than it spends. The company therefore generates more cash and cash equivalents from its operating, investing and financing activities than it needs to cover its costs.
As a result, a positive cash flow generally indicates that the company has healthy liquidity. After all, it has sufficient income to cover ongoing operating costs, make investments and service loans without having to take out additional financing.
A negative cash flow, on the other hand, means that a company spends more money than it earns. This means that more cash flows out than income is generated.
A negative cash flow can therefore be an indication of liquidity problems. It could indicate that a company is having difficulty meeting its current obligations (such as wage payments, supplier payments and loan repayments) if it does not raise additional funds.
In the case of negative cash flow, however, it is important to always consider the background. For example, it may be that the company has simply made large investments from its savings in the period selected for the cash flow calculation and is therefore not in a bad financial position despite a negative cash flow.
Nevertheless, the aim should always be to achieve a positive cash flow wherever possible. You have numerous different options for improving your company's cash flow, such as
Always keep an eye on your expenses and regularly check whether there are expenses that you can reduce or even cancel completely. Many companies negatively impact their cash flow because they ignore costs that are not (or no longer) necessary. Cash flow can be improved by controlling operating costs, production costs and labour costs, among other things.
Issue invoices directly after the delivery of goods or the provision of services and formulate the payment terms so clearly that your customers can see at a glance when payment is due. The granting of discounts also increases the likelihood that outstanding invoices will be paid more quickly.
You should also keep an eye on outstanding invoices and send regular payment reminders - automated by means of a tool if necessary. If the payment term has been exceeded, you should act immediately and contact the debtor to agree payment plans or even initiate debt collection proceedings.
Think about strategies to increase sales efficiency, as an increase in sales usually has a positive effect on cash flow. Well-planned marketing activities, product innovations and the development of new markets, among other things, can increase your revenue.
Optimise your stock levels. To improve cash flow, you should avoid excess stock in order to minimise the capital tied up in goods and thus increase liquidity.
Cash flow can also be improved through negotiations with suppliers. For example, negotiate more favourable payment terms. Even extending the payment term can help to improve your cash flow.
Effective debt management is also necessary to improve your cash flow. This means that you should negotiate appropriate financing terms and interest payments to reduce the burden on your cash flow.
To improve cash flow in the short term, you can also consider postponing investments. You should always weigh up the cost-benefit factor - because a negative cash flow is not necessarily a bad thing, especially when it comes to investments.
If you want to improve your cash flow in the short term, you can also use financing instruments such as factoring or working capital loans. You can use these options to increase your liquidity in the short term - but long-term options are of course generally preferable.
You should get into the habit of always keeping an eye on your company's cash flow. By continuously monitoring and forecasting cash flow, you can recognise financial bottlenecks at an early stage and take appropriate measures to mitigate or completely avoid these bottlenecks.
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No, cash flow is not the same as profit. Just because a company has a high cash flow does not automatically mean that it has also made a high profit. Profit and cash flow are both important indicators for companies, but they measure different aspects of financial performance.
It is possible for a company to make a profit but at the same time have a negative cash flow, for example because it has high capital expenditure or because customers pay late. Or the company can make a loss (negative profit) and still generate a positive cash flow, for example because it might continue to generate cash and cash equivalents.
Cash flow is an important key figure for every company and should therefore be calculated on a regular basis. It provides an insight into the company's actual financial performance and liquidity. This allows important decisions to be made for the future.
In addition
Yes, it is good for a company to have a high cash flow. Finally, a high cash flow indicates that the company has sufficient capital available to make new investments, for example. In addition, a high cash flow strengthens the confidence of investors, creditors and other stakeholders.
Cash flow is calculated for a period of time, while liquidity relates to a specific point in time. Cash flow therefore refers to the change in liquidity over a certain period of time.
Free cash flow, also known as positive, freely available cash flow, is the amount that is freely available to a company. This means that it has already covered all current expenditure and made investments and now has money at its free disposal.
The free cash flow can be used, for example, to build up a buffer for bad times, hire additional employees, withdraw profits or repay loans early.
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