What is cash flow in simple words?

27 января 2020 by Forex Broker simple-accounting.org

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Cashflow is one of the most important economic terms for today, which is used for financial analysis of any enterprise, regardless of its size. Although it appeared not so long ago, at the moment, its analysis and planning are carried out by all companies. Today, I will try to tell in simple language, “What is the cash flow?”, what it is used for, and how to increase the efficiency of economic activity with its help not only for business but also for a personal or family budget. 

Cash flow statement

The very definition of cash flow in a simple language is the movement of finances over a certain period. This is the difference between income and expenditure. It is easy to understand this on the example of a school math problem. For example, water flows from pipe A into a pool (that is, financial means), and it flows out from pipe B. If more water is poured into the pool, then we can talk about positive cash flow, and if more is flows out – about the negative. This is the cash flow statement. 

How to calculate cash flow: a practical example

It is useful to know how to calculate free cash flow. To calculate cash flow, you need to allocate the same periods for its calculation: weeks, months, or years of business. You will then summarize and compare the total cash flow for the selected period to the amount at the beginning of the period. If this amount is greater – your cash flow is positive. 

The free cash flow formula is very simple. For example, an electronics store may have $3,000,000 at the beginning of the month in its bank account. During the month, it will have cash from sales of goods, but also utility bills, employee salaries, and, for example, bills to repay loans. At the end of the month, you need to calculate all these expenses and take into account the income and see what the level of cash turned out in total. If it is more than 3 million dollars, the cash flow is considered positive. Otherwise-negative.

How to control the cash flow

Cash flow is an important indicator of the company. If an electronics store has a positive cash flow rate, then it has good and proper management and performs its function as a business well. The opposite is true of negative cash flow. The viability of the store may be in question if you have a negative indicator for several months in a row. Thanks to its tracking, business management can decide what is best to change: add investment to the project, improve personnel, or expand the product variety to increase sales. If the store continues to have a negative indicator month after month, it may be closed. Sometimes, you can observe a discounted cash flow. In the latter case, to avoid loss of business, it is necessary to take many appropriate actions: reduce rental costs, reduce the number of employees or take a loan for business development. Perhaps you should, on the contrary, recruit a more competent team of employees. There can be a huge number of options. The main thing is to take the necessary measures in time. If your business has a positive indicator, it will help to attract additional investment into the business, as well as pay for long-term costs soon. Thus, the cash flow rate is the most important calculation to check the viability of the business and its management.

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