Cash Flow: What It Is, How To Do It

Cash flow is one of the most important tools in financial management . It provides a clear view of the business and helps a lot in decision making.

Knowing this, We have prepared a complete guide on the subject for you who are looking for more information and want to start doing this control correctly.

In this post, in addition to checking out some concepts about this indicator, you will also understand its relevance , how to do it in practice , how to control it and what tools exist on the market today that can help with this type of monitoring within the financial sector.

What is cash flow?

Cash flow is a report with information about all movements of money spent or received by the organization in a given period of time.

Basically, its objective is to check the balance available at present and project the future, so that the company always has accessible working capital both for the cost of its operations (paying employees, taxes and suppliers, for example) and for investments (improvements in product or service, growth and expansion).

What are the types of cash flow?

A lot of individuals are unaware that there are several forms of cash flow. Find out below what some of their traits are.

What is free cash flow?

Free cash flow , as the name suggests, refers to a free amount after payment of all that are considered financial obligations of the business . It is related to the ability to generate positive results in the short, medium and long term. It is generally used for investments in new projects and for paying off debts.

What is operating cash flow?

The idea behind operating cash flow is to survey the company’s financial movements (revenues and operating expenses) over a specific period. This calculation does not take into account investments, interest and taxes , so its equation is as follows:

LAJIR + Devaluation – LAJIR Tax

*Earnings Before Interest and Income Tax (EBIT)

What is projected cash flow?

The purpose of projected cash flow is to estimate the company’s financial situation in the future . Therefore, an analysis is made of the current capital inflows and outflows , taking into account internal and external factors (seasonal changes, for example). It helps a lot when it comes to anticipating scenarios and strategies , identifying possible risks.

What is incremental cash flow?

Incremental cash flow shows the movements throughout the planning of a project . It allows us to notice the economic impacts that this project can bring to the company and to understand aspects such as profitability and viability. Basically, incremental cash flow expresses the economic income that can be added with the investment in a new project.

What is direct cash flow?

Direct cash flow refers to monitoring the financial health of a business in its accounting nature, since it considers records of gross receipts and payments . It is widely used in the corporate world and helps in better decision-making.

What is indirect cash flow?

Indirect cash flow is based on the budget year and the Income Statement (IS), a report that presents a summary of a company’s operating and non-operating results. It aims to adjust amortization, depreciation and changes in balance sheets, which do not affect cash directly, but rather profits .

What is discounted cash flow?

Discounted cash flow brings a company’s future cash flow to the present (with a discount rate). This discount rate usually includes all the capital costs and risks of the enterprise. Thus, it works with the valuation of a company, involving a projection for the purchase and sale of shares or in mergers and acquisitions .

Discounted cash flow valuation

According to experts, discounted cash flow is the best-known method on the market for calculating a company’s valuation . This calculation takes into account the company’s cash flows minus the discount rates (which represent the investor’s opportunity cost). The value found is the company’s valuation .

Importance of cash flow

The management of cash flow will form an important part of the financial management of any company because it will act as a tool for control, which means that inflow and outflow of financial resources can be monitored strictly.

It is sort of a compass that guides the path to be followed. This instrument provides managers with a clear and precise view of the financial health of the organization, thereby allowing them to make informed decisions, anticipate challenges, and capitalize on opportunities.

With effective control of cash flow, the business entity can maintain its financial stability and thus honor commitments, invest in growth, and avoid unpleasant surprises.

It is thus fundamental to understand and manage cash flow, becoming the ideal skill required by entrepreneurs and financial managers for sustainability of the firm’s success.

What to do when cash flow is negative?

The math in a company’s finances ends up being quite simple: only what comes in should go out, right? The point is that a company’s accounts payable and receivable control works differently.

Cash outflows each month are more predictable (employee salaries, taxes, rent). On the other hand, cash inflows are harder to predict because there is a risk of default and late payments.

You may often spend more than you earn. This can happen, for example, because the company is making a large investment in launching a new product or even expanding its operations. But the fact is that you need to be careful, because the operation has to pay for itself one day.

When cash flow is negative , it is important to restructure expenses so that the operation becomes leaner. This means reviewing everything to try to reduce total expenses .

Here, it is important to remember that restructuring can be divided into points that cost and those that do not cost the company. For example, in the short term, if you do not have cash, you cannot fire people because this generates a cost.

The solution could be a complete review of all contracts for the supply of inputs and services, seeking better conditions for these contracts and creating space in the cash flow for measures to reduce the costs involved.

Since a negative balance can also indicate differences between receipt and payment terms, it is essential to plan and organize working capital . Therefore, the recommendation is to build up a reserve of this capital by reviewing the company’s financial calendar.

Loans are usually the most sought-after alternatives, but they should not be seen as the first solution. Caution is a great ally at this time, so that you do not take on debts beyond your means and have difficulty paying off your commitments.