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Cash Flow

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Cash Flow

Imagine you wanted to know how well your business is doing. How would you find out? How would you determine how much money was coming into the business and how much you needed to cover expenses?

The first thing you could do to answer these questions is to look at cash flow. Cash flow is directly related to all the money coming in and out of business. It's one of the most important metrics investors use when assessing a company's value. This explanation will teach you everything you need to know about the topic of cash flow. In the end, you'll be able to make sense of any company's cash flow.

Cash flow definition

Cash flow refers to the money that comes into the business, as well as the money that leaves the business. That is to say, it records and calculates all the money circulating within the company. There are many reasons why cash goes into or leaves a business.

Money coming into the business is referred to as cash inflow. Cash inflow results from the business activities that a company engages in.

There are different types of cash inflow. The most common ones are:

  • Income from sales: This represents all the money a business makes from selling its products or services. All the income from this source creates cash for the business.

  • Bank loans: Often businesses use bank loans to finance their business activities, such as buying raw materials, renting offices, etc. This is considered to be a cash inflow.

  • Investments: This type of cash inflow includes the business owners' money into their business and the money that a business has managed to secure through other investors.

On the other hand, businesses also experience money leaving the firm. This money may be used for different purposes, such as paying for salaries or raw materials to keep the production going.

The money that leaves the business is known as cash outflow.

Types of cash outflows include:

  • Raw materials: All the money that a business spends on raw materials to manufacture final products is a cash outflow.

  • Wages: All the wages that a business has to pay to its employees are cash outflows. That is due to the money leaving the business and counted as an expense.

  • Rent/ Mortgage: Many businesses need a building from where they can operate, and to get that building, they would have to either rent it or buy it. In both cases, it causes a cash outflow for the business.

  • Interest payments: The payments that a business makes towards interest on the loans that they took out is a cash outflow.

Cash Flow, Cash inflows and outflows, StudySmarter

Cash inflows and outflows, StudySmarter Originals

Cash flow v profit

Often people confuse cash flow and profit. Although they might have many similarities, they are not quite the same.

Profit refers to the difference between a business’s revenue and total expenses.

Profit usually belongs to the owners of a company.

In contrast, cash flow refers to the money that moves in and out of business. In contrast to profit, cash flow is more about the business than business owners. Cash flow enables businesses to cover all the expenses while providing final goods or services.

Profit is concerned with the money left after all the expenses are covered, whereas cash flow is concerned with the net flow of funds.

Both cash flow and profit are essential factors for business owners and investors. These metrics are used when assessing how successful a business is. Many companies show a positive cash flow, but are making a negative profit. This doesn’t mean that the firm failed - they were simply able to keep going for some time without a profit, as the inflows were enough to cover cash outflows.

Cash flow statement

Another important part of the cash flow is the cash flow statement.

The cash flow statement is a financial statement that points out all the money that has come in or left the business.

This financial statement is very important for investors. Investors are significantly concerned and always look for whether a company will have a positive cash flow in the future, meaning that there's more money coming in than leaving the business.

Cash Flow Statement ENRE LTD

MarchApril (forecast)
Cash inflows
Bank loan20,000
Sales revenue12,00015,000
Total cash inflow32,00015,000
Cash outflows
Raw materials8,0009,000
Wages21,00022,000
New Equipment5000
Total cash outflow29,50031,000
Net cash flow2,500(16,000)
Opening balance20004,500
Closing balance4,500(11,500)

Figure 1. Cash Flow Statement ENRE Ltd

The table above shows an example of what a business's cash flow statement looks like. Note that March is the actual month, and April is the month forecast. A typical cash flow statement has three sections that you need to keep in mind.

Cash flow forecast refers to the estimates of a company's future cash flows.

It starts by having the cash inflows at the top of the statement. All of the cash inflows added together equal the total cash inflow. We can see that ENRE Ltd's cash inflows for March add up to £32,000.

Then you have the cash outflows. After accounting for all the cash outflows, you add them up to develop the total cash outflow. In our example, cash outflows in March are equal to £29,500.

The third section is the net cash flow, which is calculated by subtracting the total cash inflows from the total cash outflows. From our example above, you can see the net cash flow:

£32,000 - £29,500 = £2,500

Opening balance refers to the amount that the business started the month with, whereas closing balance refers to the amount of money the business has been left with at the end of the month. Opening balance, in this case, was £2,000, whereas by the end of the month the company had:

£2,000 + £2,500 (the net cash flow) = £4,500

as their closing balance.

Cash flow forecast analysis

The cash flow forecast estimates the planned cash inflows and outflows of ENRE Ltd during April. Figure 1 shows that the company is expected to have a negative net cash flow by the end of April. That is because the cash inflow has not increased by as much, only £3,000, which is calculated by taking the difference between cash inflows in April and March:

£15,000 - £12,000 = £3,000.

At the same time, the business expects to increase total outflows by £1,500 (£31,000 - £29,500 = £1,500).

This analysis is very useful to business managers, as it helps them properly plan what they will do with the negative net cash flow they are expecting. Business owners can use this information to decide whether they want to reduce total outflow or seek more financing into the business to bring in cash inflows.

The cash flow also enables business owners to find out where the cash outflow is coming from, which in this case, there are three main sources: raw materials, wages, and new equipment.

Advantages of having positive cash flows

Many advantages come with a positive cash flow. One of the major benefits is getting loans. If you want to grow your firm, you may need to take out a small business loan. To be eligible, you must show that your firm is stable and generates consistent revenue. This need may be met by having a solid cash flow.

Even though you might not get a loan, a positive cash flow will significantly help expand your business. There are two main ways in which this can be done. Firstly, you could have the extra inflows used to invest in new projects to expand. This expansion may take the form of establishing a new business site, expanding into a new market, purchasing new equipment, etc.

Secondly, a positive cash flow is always attractive to investors. You could have other people invest in your business and use that money to develop your operations further and generate more sales.

Lastly, a positive cash flow assists a company in meeting financial obligations. In the early stages of a new firm, it is common to depend on credit to pay for costs, including staff salaries. Nevertheless, after the firm has established itself, it will be able to utilize cash flow to reduce its debt. This reduces the cash flow problems a business might run into and, as a result, reduces the risk of failure.

Cash flow management

Good cash flow management is the most critical part of any company's operations. It increases the chance of a business having a positive cash flow, which allows the company to pay its employees on time and have enough capital to invest in its development and expansion.

Additionally, performing business analyses and staying up to date with recent developments allows the company to achieve a better cash flow forecast and make decisions about the future accordingly.

Inefficient management of the business's cash flow is one of the leading causes of cash flow problems. This is especially true for small businesses that lack the financial expertise to manage cash flow properly. However, big companies can also face problems arising from poor management.

Solutions to cash flow problems

There are two critical factors to consider when finding a solution to business problems. Cash flow managers should consider finding the source of the cash flow problem and analysing the business's circumstances. This helps provide for more efficient and accurate management of cash flow.

Some of the solutions that you can implement to cash flow problems include:

  • Rescheduling payments. When you face cash problems and see an imbalance between cash inflows and cash outflows, it is better to ask suppliers whether you can pay them later. That way, you delay cash outflows which then helps cover the expenses of raw materials.

  • Using overdrafts. Overdrafts is another alternative solution to cash flow problems. This includes taking out small short term loans to cover the cash outflows. It is a widespread practice amongst cash flow managers.

  • Cutting cost. Cutting costs significantly helps reduce the cash outflows when a business is having cash flow problems. It is a solution that usually involves finding alternative and cheaper raw materials, cutting the cost of fuel, etc.

To sum up, cash flow shows the financial situation of a company throughout a period. It focuses on showing and accounting how much money enters and leaves the company. The cash flow is important to businesses for them to better manage their company. Additionally, the cash flow is important for investors as it is one of the most significant tools in valuing a company.

Cash Flow - Key takeaways

  • Cash flow refers to the money that comes into the business and the money that leaves that business.
  • Money coming into the business is known as cash inflow, whereas money leaving the business is known as cash outflow.
  • There are different types of cash inflow; the most common is are income from sales, bank loans, and investments.
  • Types of cash outflow include raw materials, wages, rent/mortgage, and interest payments.
  • The difference between cash flow and profit is that profit is concerned with the money left after all the expenses are covered, whereas cash flow is concerned with the net flow of funds.

  • An important part of cash flow is also the cash flow statement, a financial statement that points out all the money that has entered or left a business.

  • A cash flow forecast estimates the planned cash inflow and outflow during a certain period.

Frequently Asked Questions about Cash Flow

Cash flow enables businesses to cover all the expenses while providing final goods or services. Cash flow is also used in assessing the success of a business.

Cash flow management increases the chance of a business having a positive cash flow, which allows the company to pay its employees on time and have enough capital to invest in its development and expansion.


Additionally, performing business analyses and staying up to date with recent developments allows the company to achieve a better cash flow forecast and make decisions about the future accordingly.

Cash flow refers to the money that comes into the business, as well as the money that leaves the business. That is to say, it records and calculates all the money circulating within the company. 

The cash flow forecast estimates the planned cash inflows and outflows of a company. This analysis is very useful to business managers, as it helps them properly plan the business activities with the expected cash flow.


Business owners can use this information to decide whether they want to reduce total outflow or seek more financing into the business to bring in cash inflows. 


The cash flow also enables business owners to find out where the cash outflow is coming from, such as raw materials, wages, and new equipment. 

Reducing cash outflows, and increasing cash inflows are ways to improve cash flow.

Final Cash Flow Quiz

Question

What is cash flow?

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Answer

Cash flow refers to the money that comes to the business and the money that leaves the business. 

Show question

Question

What is cash inflow?

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Answer

Money coming into the business is known as cash inflows.

Show question

Question

What is cash outflow?

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Answer

Money leaving the business is known as cash outflows.

Show question

Question

What are the three different types of cash inflows?

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Answer

There are different types of cash inflows; the most common ones are:Income from sales, Bank loans, Investments.

Show question

Question

What are some type of cash outflows?

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Answer

Types of cash outflows include: Raw materials, Wages, Rent/ Mortgage, Interest payments. 

Show question

Question

What is the difference between cash flow and profit?

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Answer

The difference between cash flow and profit is that profit is concerned with the money left after all the expenses are covered, whereas cash flow is concerned with the net flow of funds.

Show question

Question

What is the cash flow statement?

Show answer

Answer

An important part of the cash flow is also the cash flow statement, a financial statement that points out all the money that has come in or went out of the business.

Show question

Question

What does cash flow forecast estimate?

Show answer

Answer

A cash flow forecast estimates the planned cash inflows and outflows during a certain period.

Show question

Question

Why good cash flow management is important for a company?

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Answer

 It increases the chance of a business having a positive cash flow, which allows the company to pay its employees on time and have enough capital to invest in its development and expansion

Show question

Question

What are some of the benefits of having positive cash flow?

Show answer

Answer

Many advantages come with a positive cash flow. One of the main and first benefits a business gets by having a positive cash flow is getting loans. Even though you might not get a loan, a positive cash flow will significantly help you expand your business. 

Show question

Question

What is one of the main causes of cash flow problems?

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Answer

Inefficient management of cash flow.

Show question

Question

What are some of the solutions to cash flow problems?

Show answer

Answer

  • Rescheduling payments. 
  • Using overdrafts. 
  • Cutting cost. 

Show question

Question

What does profit refer to?

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Answer

Profit refers to the difference between a business’s revenue and total expenses.

Show question

Question

Where is interest payment in cash flow statement?

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Answer

Part of the outflows.

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Question

What are the three mains sections of a typical cash flow statement?

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It starts by having the cash inflows at the top of the statement. And after all of the cash inflows are added together, it makes the total cash inflow. 

Then you have the cash outflows. After accounting for all the cash outflows, you add them up to develop the total cash outflow.

The third section is the net cash flow, which is basically calculated by taking the total cash inflows from the total cash outflows. 

Show question

Question

What are the four solutions to cash flow problems?


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Answer

  • Rescheduling payments
  • Using overdrafts
  • Cutting costs
  • Finding new sources of cash inflows


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Question

What payments can be rescheduled?

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  • Payments to suppliers and other parties to whom a business owes money
  • Payments that are to be made by customers


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Which payments, when sped up, can help to solve the cash flow problems?


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Answer

Payments that are to be made by customers


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Question

What is an overdraft?

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An overdraft is a short-term flexible loan a business can use whenever it needs.


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What are the advantages of an overdraft as a method to solve the cash flow problems?


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It is a quick and easy way of gaining money that provides an immediate inflow of cash. 


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What are the disadvantages of an overdraft as a method to solve the cash flow problems?


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An overdraft is associated with an interest charge that can make it expensive and damage the profits of a firm. Moreover, it needs to be agreed upon with a bank that might withdraw it on very short notice.


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Question

Give an example of an action that can cut costs of a business.


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Answer

For example:

  • finding alternatives by using cheaper sources of raw materials or fuel
  • employing fewer staff
  • holding smaller stocks


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Question

What are the disadvantages of cutting costs as a method to solve the cash flow problems?


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Answer

It can reflect on the quality of products or services offered by a firm. As lower quality can lead to customers dissatisfaction, used in the long term, cutting costs can lead to losing customers.


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What is the benefit of finding new sources of cash inflows as a method to solve the cash flow problems?


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Answer

It can bring significant amounts of cash inflows.


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What are the disadvantages of finding new sources of cash inflows as a method to solve the cash flow problems?


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Answer

It can take time to implement and involve additional costs and cash inflows.

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Question

What should managers consider to find the right solution to cash flow problems?


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Answer

find the cause of the cash flow problem and analyse the business's circumstances


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What is meant by the business’s circumstances?


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a situation of a business

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Why can finding the cause of the cash flow problem be crucial for managers?


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This is because then they will know what exactly has to be solved and how to act to prevent it from happening in the future.


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When customers buy on credit, a business is deprived of…


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Cash inflows

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When some customers owe money that was due in the past, a company can try…


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Answer

chasing them and insisting on paying promptly.


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When a business experiences cash flow problems, its cash flow is…


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Answer

negative.

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When a business experiences cash flow problems...


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Answer

more money is coming out than coming into the business.

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Question

Give an example of an effect of cash flow problems.

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Answer

For example: 

  • late or unpaid debts,
  • inability to pay suppliers,
  • inability to pay staff wages,
  • inability to buy inventory.


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Question

What are some common causes of cash flow problems? 


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Answer

  • poor management
  • making a loss
  • offering customers too long to pay


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What is meant by poor management by cash flow problems?


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Answer

Sometimes managers are simply unaware of the importance of cash flow management and therefore, they do not plan it carefully. 


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Does making a loss have to mean that a business’s cash flow is negative?


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Answer

No

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Why can businesses experience cash flow problems when customers are offered too long to pay?


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Because in spite of making transactions and spending money on the production of certain goods or services, a business does not receive any money.


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Question

Give an example of a method to solve cash flow problems. 


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Answer

For example: 

  • rescheduling payments,
  • using overdraft, 
  • cutting costs, 
  • finding new sources of cash inflows.


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Net cash flow always equals…


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Answer

Closing balance


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Cash flow problems caused by poor management are more likely to occur in...


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smaller firms.

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Why are cash flow problems caused by poor management more likely to occur in smaller firms?


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Answer

Because smaller firms tend not to employ managers who would take care particularly for finance.


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The right solution to cash flow problems should be found based on…


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the causes of cash flow problems and the business circumstances.


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Negative cash flow is when a business spends more money than…


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Answer

it receives.

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Question

What is an overdraft?


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Answer

An overdraft is a short-term flexible loan a business can use whenever it needs.


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What can inability to buy inventory result in?


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Answer

It can refrain companies from buying inventory and as a result, stop their operations.


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What is a cash flow forecast?

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Answer

Cash flow forecast is a prediction of a business’s net cash flow over a future period. 


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What is cash inflow and cash outflow?

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Answer

  • The amount of money going in a business is called cash inflows, e.g. sales revenues.
  • The amount of money going out of a business is called cash outflow, e.g. raw materials purchases, interest payments, rent.

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What does negative cash flow mean?

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Negative cash flows happen when the company has more money flowing out than flowing in. This indicates a high chance of future cash shortage. 

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What does positive cash flow mean?

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Positive cash flows occur when the company has more money flowing in than flowing out. This shows the business is more able to meet its operations needs and buffer against financial challenges. 

Show question

Question

How to calculate net cash flow?

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Answer

Net cash flow is calculated as cash outflows minus cash inflows.

Show question

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