Have you heard of cash flow before – whether I say cash flow, cash flow or cash flow sounds more familiar? These terms refer to an important indicator in determining the financial health of a company. Therefore, it is essential to know what it is, its types and advantages, as well as the best method to calculate it and obtain business benefits.
What is Cash Flow?
Cash flow evaluates the economic health of a company. But what does it mean? It means that it determines its financial status, the company’s ability to generate profits and meet payments in a given period.
Calculating and carrying out the balance sheet of a company is not enough, carrying out the cash flow will help us to know if our company is able to meet its expenses, making reference to liquidity. It is a key and indispensable piece when it comes to managing the company, taking into account investments or disbursements and income and expenditure forecasts.
It can be said that cash flow is the sum of net profit, provisions and amortisations. Likewise, with this tool we can evaluate and analyse how our company is working, its profitability and how it can go in the future and if the established objectives are being fulfilled.
How to calculate cash flow correctly?
Now that we know the importance of cash flow, it is time to know its formula and how to calculate it. It is as simple as that to calculate the cash flow of a company:
Cash flow = net profit + provisions + depreciation and amortisation
After obtaining the net result, the depreciation and amortisation allowances are added together with the provisions at a given moment in time. Why? Provisions refer to expenses caused by unforeseen events and depreciation refers to the wear and tear or depreciation of an asset over time.
The cash flow of a company can be positive or negative, as a reason for the lack of payment to suppliers, thus warning and knowing the real state of the business or the need for financing.
Advantages and benefits of calculating it
This indicator can reflect how the company is doing and where it is going. It allows us to know the liquidity problems in advance and if there is any inconvenience or obstacle in the company’s profitability. It provides from a different financial point of view the state of the company and its growth.
How do we improve the company’s results? Do we generate enough cash to meet our targets? How does an investment affect cash flow? As we can see, calculating cash flow allows us to determine whether there is excess or lack of liquidity, which is important for making financing decisions. It tells us where the money comes from, i.e. the inflows and outflows of cash flow. In addition, we can also evaluate the collection and payment policy and adjust it according to the economic activity.
But there are limitations, i.e. you have to know how to interpret the cash flow calculation and know it as a guideline when facing obstacles. The main limitation is the accrual rule, i.e. accounting profits are considered as cash, but not all profits are available as cash in hand.
Types of cash flow
Depending on the activity of the company there are three different types of cash flow:
- Operating: Operating activities depend on the income obtained from the sale of products or the provision of services related to the direct activity of the company. Directly affecting the result in this type of cash flow.
- Investment: Occurs in companies that incur in financial or real estate investments, generating cash flows.
- Financing: This depends on the financing activities within the company, taking into account those that directly affect its capital.
It is essential to know the three types of cash flow that currently exist, since if a company has positive cash flows it means that it is on the right track and if it has negative cash flows it means that it may have liquidity problems and has imbalances to be solved.
Cash flow is about identifying the money that enters and leaves the company, money that is available at the moment, that is to say, it is the real money that the company has in its cash to operate. This is why cash flow is an indispensable indicator for any company, as it shows the liquidity in the cash and the evolution in the medium and long term.
Discover XPENDOR to manage your expense notes
We know the importance of cash flow, so keeping up to date with accounting and keeping track of the financial health of our company is essential. One of the most complicated expenses to manage is business travel, but there are tools or digital solutions that allow you to digitise and keep track of corporate travel tickets or invoices.
XPENDOR allows you to automate and digitise the management of expense notes, becoming a key tool to move with ease in the competitive environment in which all companies live today.