Cash Flow –
simply explained

Key facts at a glance:

• Cash flow is a balance sheet metric for companies that indicates how much capital has flowed in and out in a given period.

• It provides information on whether the company is at risk of insolvency.

• It indicates how healthy a company is in terms of its financial position.

What Is Cash Flow?

The term cash flow refers to the flow of money or capital. Cash flow is a balance sheet metric for companies that indicates how much capital has flowed in and out in a given period.

Put simply, in a cash flow statement all receipts and disbursements over a certain period are compared. The resulting difference is the cash flow. Accordingly, cash flow can be either positive or negative.

What Is the Significance of a Positive and Negative Cash Flow?

• Positive cash flow: When more money flows into a company than flows out, a positive cash flow exists. This signals to shareholders that the company can finance future investments or financial activities from its own financial resources.

• Negative cash flow: A negative cash flow indicates that more cash is flowing out of the company than flowing in. At this point, it is worth taking a closer look at expenditures. For example, high investments in new software or machinery could be a reason for the negative cash flow. However, if cash flow is negative over a longer period, the company may even face insolvency.

How Is Cash Flow Broken Down?

The cash flow statement consists of four elements: operating cash flow, cash flow from investments, cash flow from financing activities, and free cash flow.

• The operating cash flow from business activities represents a financial metric and indicates the cash surplus generated through operating business during the period under review. Only income and expenses from normal business activities are included, for example production costs.

• The cash flow from investments indicates the balance of cash that the company has invested in the acquisition of financial and tangible assets (e.g. production facilities).

• The cash flow from financing refers to the balance of payment flows that have flowed in or out from financing activities. Inflows can come from raising equity or from taking on debt capital. Outflows, on the other hand, can result from distributions to shareholders or the repayment of liabilities.

• The free cash flow refers to the funds freely available to the company. This capital can be used, for example, for investments or distributions.

How Is Cash Flow Calculated?

There are two methods for calculating cash flow: the direct method and the indirect method.

The direct cash flow consists of cash-effective income and expenses and is calculated as follows:
Direct cash flow = cash-effective income – cash-effective expenses

The indirect cash flow is derived from the following components:
Indirect cash flow = net income – non-cash income – non-cash expenses.

The indirect cash flow is particularly used for balance sheet analysis.