Debt Dictionary

Cash Flow

Investment Dictionary -> Cash Flow

Cash flows reflect the financial health or the lifeblood of every company. The measurement of the cash flows indicates the rate of return on business projects. Cash flows can be used to measure the company's profit. For instance, companies that barter their products generate small amounts of operational cash flows. Such companies may issue shares to raise operational cash.

In addition, cash flows are used to determine the liquidity or convertibility of the company's assets into cash. The operating cash flow ratio reveals the extent of the company's liquidity. The ratio shows how well the cash flow from the operations covers the current liabilities. The access to cash is the essential precondition for financial flexibility. Liquid cash eliminates the need to look for new sources of funding. Healthy cash flows allow the company to invest in new enterprises without the approval of bankers and shareholders. On the other hand, the lack of liquidity means that the company does not have enough cash or assets that are convertible into cash. In this scenario, the company cannot meet its payment obligations. This situation may require borrowing or raising additional share capital that will serve to meet the obligations. Long-term liquidity shortages may result in insolvency.

There are two types of cash flows in terms of cash movement: cash inflows and outflows. The first type comprises of the net cash that enters the company due to its ongoing functioning. The most obvious example of cash inflows is the revenue. Conversely, cash outflows refer to the net cash that leaves the company in relation to its operational activities. The expenses are a form of cash outflow.

Cash flows are further divided into operational, investment, and financing cash flows. The operational cash flows refer to the cash that is generated from the revenues less the investment income, taxation, interest, and dividends paid. The investment cash flows have to do with cash that is received from the sale of long-term assets or spent in the form of capital expenditures. Finally, the financing of cash flows refers to cash that flows in the company as a result of share repurchases, payment of dividends, and the issue of debt and securities.

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