Before starting any business, it is important for entrepreneurs to visualize how economic activity will unfold, but especially the potential for growth and development, with the aim of generating profit. For such a financial analysis, a document is prepared that includes an estimate of the revenue and expense budget, as well as a cash flow statement.
What is cash flow?
Also known as “treasury flow” or “cash flow,” it represents the difference between the total revenues and payments of an economic entity. In other words, all the money circulating within the company constitutes cash flow.
If revenues are the amounts of money received from various clients, investors, debtors, etc., the payments of an economic entity represent the sums used to pay suppliers, employees, company associates, taxes, etc.
Cash flow model and calculation formula
The lack of funds is the main reason why many businesses go bankrupt. A cash flow report is essential in a business because it provides a clear picture of the available funds in the company.
Calculating cash flow, therefore, involves making a comparison between the amounts of money entering the economic unit and those exiting (payments).
In its net form, the cash flow formula is:
- Cash received – Cash spent = Net cash flow
Cash flow – indirect method
- The indirect method takes into account operations performed in the previous period and financial transactions that will take place in the next period.
Cash flow – direct method
- The direct method involves all cash receipts and payments, meaning physical cash transactions. This method considers the cash to be paid to suppliers, receipts from clients, and the amounts needed to ensure salary payments.
Regardless of the method used to determine cash flow, the result can indicate either a positive or a negative value.
On one hand, if the cash flow is positive, it means that the received amounts are higher than the payments, indicating that the company holds cash. On the other hand, a negative cash flow shows that the company’s revenues are lower than the payments made, which may signal a problem in the economic management of the business.
Attention! A negative cash flow can lead an economic unit to bankruptcy, as a company cannot function without liquidity, meaning assets that can be easily converted into cash.
In conclusion, cash flow is an important indicator that reflects the financial situation of the company while also providing an outlook on the unit’s development prospects in the future. To avoid driving the company into bankruptcy and to maintain it on a balanced economic path, it is essential that all cash flows are analyzed with great responsibility and transparency.