What is Cash Flow ?

 What is Cash Flow ?

Cash flow is the net amount of cash and cash equivalents being transferred into and out of a business. Cash received represents inflows, while money spent represents outflows.

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At a fundamental level, a company’s ability to create value for shareholders is determined by its ability to generate positive cash flows or, more specifically, maximize long-term free cash flow (FCF). FCF is the cash that a company generates from its normal business operations after subtracting any money spent on capital expenditures (CapEx).

Cash Flow Categories:

1. Cash Flows from Operations (CFO): CFO, or operating cash flow, describes money flows involved directly with the production and sale of goods from ordinary operations. CFO indicates whether or not a company has enough funds coming in to pay its bills or operating expenses. In other words, there must be more operating cash inflows than cash outflows for a company to be financially viable in the long term.

Operating cash flow is calculated by taking cash received from sales and subtracting operating expenses that were paid in cash for the period. Operating cash flow is recorded on a company's cash flow statement, which is reported both on a quarterly and annual basis. Operating cash flow indicates whether a company can generate enough cash flow to maintain and expand operations, but it can also indicate when a company may need external financing for capital expansion. 

Note that CFO is useful in segregating sales from cash received. If, for example, a company generated a large sale from a client it would boost revenue and earnings. However, the additional revenue doesn't necessarily improve cash flow if there is difficulty collecting the payment from the customer.

2. Cash Flows from Investing (CFI): CFI, or investing cash flow, reports how much cash has been generated or spent from various investment-related activities in a specific period. Investing activities include purchases of speculative assets, investments in securities, or the sale of securities or assets.

Negative cash flow from investing activities might be due to significant amounts of cash being invested in the long-term health of the company, such as research and development (R&D), and is not always a warning sign.

3. Cash Flows from Financing (CFF): CFF, or financing cash flow, shows the net flows of cash that are used to fund the company and its capital. Financing activities include transactions involving issuing debt, equity, and paying dividends. Cash flow from financing activities provides investors with insight into a company’s financial strength and how well a company's capital structure is managed.

Statement of Cash Flows: 

There are three critical parts of a company's financial statements: the balance sheet, the income statement, and the cash flow statement. The balance sheet gives a one-time snapshot of a company's assets and liabilities. The income statement indicates the business's profitability during a certain period.

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The cash flow statement differs from the other financial statements because it acts as a corporate checkbook that reconciles the other two statements. The cash flow statement records the company's cash transactions (the inflows and outflows) during the given period. It shows whether all of the revenues booked on the income statement have been collected.

Analyzing Cash Flows:  Using the cash flow statement in conjunction with other financial statements can help analysts and investors arrive at various metrics and ratios used to make informed decisions and recommendations.

1. Debt Service Coverage Ratio (DSCR): 

Even profitable companies can fail if their operating activities do not generate enough cash to stay liquid. This can happen if profits are tied up in outstanding accounts receivable and overstocked inventory, or if a company spends too much on capital expenditures (CapEx).Investors and creditors, therefore, want to know if the company has enough CCE to settle short-term liabilities. To see if a company can meet its current liabilities with the cash it generates from operations, analysts look at the debt service coverage ratio (DSCR).

     2. Free Cash Flow (FCF): To understand the true profitability of a business, analysts look at free cash flow (FCF). FCF is a really useful measure of financial performance and tells a better story than net income because it shows what money the company has left over to expand the business or return to shareholders, after paying dividends, buying back stock, or paying off debt.

Free Cash Flow = Operating Cash Flow - Capital Expenditures

3. Unlevered Free Cash Flow (UFCF): For a measure of the gross FCF generated by a firm, use unlevered free cash flow (UFCF). This is a company's cash flow excluding interest payments, and it shows how much cash is available to the firm before taking financial obligations into account. The difference between levered and unlevered FCF shows if the business is overextended or operating with a healthy amount of debt.

Investments in property, plant, and equipment and acquisitions of other businesses are accounted for in the cash flow from investing activities section. Meanwhile, proceeds from issuing long-term debt, debt repayments, and dividends paid out are accounted for in the cash flow from financing activities section.

The main takeaway is that Walmart's cash flow was positive (an increase of $742 million). That indicates that it has retained cash in the business and added to its reserves in order to handle short-term liabilities and fluctuations in the future.

(Article source from: https://www.investopedia.com/terms/c/cashflow.asp)

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