Cash flows are movements of money into or out of a business, project, or financial product. Understanding different types of cash flows is essential for financial analysis, planning, and decision-making. Here are the primary types of cash flows:
1. Operating Cash Flows (OCF)
Operating cash flows are the cash inflows and outflows related to the core business operations. They include:
- Cash receipts from sales of goods and services.
- Cash payments to suppliers and employees.
- Cash generated from operations before interest and taxes.
Example: Cash received from customers, cash paid for inventory, wages, rent, utilities, and other operational expenses.
2. Investing Cash Flows (ICF)
Investing cash flows are associated with the acquisition and disposal of long-term assets and investments. They include:
- Cash payments to acquire property, plant, and equipment (PPE).
- Cash receipts from the sale of PPE.
- Cash payments for purchasing investments in other companies.
- Cash receipts from the sale of investments.
Example: Cash used to purchase new machinery, cash received from selling an old building, cash invested in another company’s stocks or bonds.
3. Financing Cash Flows (FCF)
Financing cash flows relate to the funding of the business and the return of funds to the investors. They include:
- Cash proceeds from issuing equity or debt.
- Cash repayments of amounts borrowed.
- Cash payments for dividends.
- Cash payments for share buybacks.
Example: Cash received from issuing shares, cash paid to repay a loan, dividends paid to shareholders.
4. Free Cash Flow (FCF)
Free cash flow is the cash generated by the business that is available for distribution to the company’s security holders after accounting for capital expenditures necessary to maintain or expand the asset base. It is calculated as:
FCF = Operating Cash Flow − Capital Expenditures
FCF=Operating Cash Flow−Capital Expenditures
Example: Cash left over after paying for new equipment and maintaining existing assets.
5. Net Cash Flow
Net cash flow is the sum of the cash flows from operating, investing, and financing activities over a period. It indicates the overall change in the cash position of a business.
Example: Total cash inflows minus total cash outflows over a fiscal quarter.
6. Cash Flow from Assets (CFA)
CFA = Operating Cash Flow − Net Capital Spending − Changes in Net Working Capital
CFA = Operating Cash Flow − Net Capital Spending − Changes in Net Working Capital
Example: Cash generated from operating activities adjusted for investments in capital and changes in working capital.
Understanding these different types of cash flows helps in assessing a company’s financial health, making investment decisions, and managing day-to-day financial operations.
How cash flow is calculated?
1. Direct Method
The direct method involves calculating cash inflows and outflows directly from the company’s cash receipts and cash payments.
Steps:
- Cash Receipts from Customers: Include all cash sales and collections from accounts receivable.
- Cash Payments to Suppliers and Employees: Sum up all cash payments for inventory, operating expenses, wages, and taxes.
- Net Cash Provided by Operating Activities: Subtract the total cash payments from the total cash receipts.
2. Indirect Method
The indirect method starts with net income and adjusts for changes in non-cash accounts, changes in working capital, and non-operating gains or losses.
Steps:
- Start with Net Income: Obtain this from the income statement.
- Adjust for Non-Cash Items: Add back non-cash expenses (e.g., depreciation, amortization).
- Adjust for Changes in Working Capital: Include changes in accounts receivable, accounts payable, inventory, and other current assets and liabilities.
- Adjust for Non-Operating Items: Subtract gains and add back losses that are not related to operating activities.
Activities:
1. Operating Activities
These include the primary revenue-generating activities of the business.
Inflows: Cash sales, collections from customers, interest, and dividends received.
Outflows: Payments to suppliers, employees, taxes, interest paid.
2. Investing Activities
These are activities related to the acquisition and disposal of long-term assets and investments.
Inflows: Sale of property, plant, and equipment, sale of investments.
Outflows: Purchase of property, plant, and equipment, purchase of investments.
3. Financing Activities
These involve changes in the size and composition of the equity and borrowings of the entity.
Inflows: Issuance of shares, issuance of debt (bonds, loans).
Outflows: Repayment of debt, payment of dividends, repurchase of shares.