Overview of Net Cash Flow
Net cash flow is the amount of cash generated or lost over a specific period of time, usually over one or more reporting periods. This concept is used to discern the short-term financial viability of a business, which is considered to be its ability to generate cash.
If a company is consistently generating positive net cash flow over a long period of time, this is the best indicator of its viability. Conversely, continuing negative net cash flow is the prime indicator of any number of operational or financing problems (though it could also mean that a business is growing rapidly and so requires more working capital than usual).
However, you cannot use net cash flow as the sole determinant of financial viability. You should measure net cash flow in conjunction with any changes in the level of debt (since additional borrowing also increases cash flows), the sale of any fixed assets (which can generate cash), and changes in the ongoing maintenance of the business (such as for equipment maintenance, employee training, and research and development). These additional items indicate that, despite apparently strong net cash flow, a company's overall competitive position has actually declined. More items that can skew the net cash flow figure are included in the "financing activities" and "investment activities" bullet points below.
Net cash flow is comprised of three forms of activities, which are:
- Operations. This is cash both generated and used by the basic operations of a business, such as cash receipts from customers and expenditures for cost of goods sold and administrative expenses.
- Financing activities. This is cash received through a debt agreement, or cash issued to pay off a debt, repurchase company shares, or pay out a dividend.
- Investment activities. This can be cash received from a gain on an investment, or cash issued to buy an investment instrument or purchase fixed assets.
Net cash flow is not the same as the net profit or loss reported by a business, since that measure (for a business reporting under the accrual basis of accounting) includes a variety of accruals for both revenue and expenses that do not indicate the actual flow of cash.
Net cash flow is closely tracked by the treasurer, who needs this information to predict the cash needs of a business, which he or she uses to either plan for investments having different maturity dates, or for the acquisition of additional debt.
Net Cash Flow Formula
Net cash flow can be derived through either of the following two methods:
- Cash receipts minus cash payments. This appears at first to be the most direct method of deriving net cash flow, but the accounting transaction recording system does not aggregate or report information in this manner. Consequently, the next method is used.
- Net profits plus non-cash expenses. This approach begins with the net profit or loss figure at the bottom of the income statement and then adds back all non-cash expenses, which typically include depreciation, amortization, and depletion.
Net Cash Flow Reporting
A summary of the cash flows of a business is formalized within the statement of cash flows, which is a required part of the financial statements under both the GAAP and IFRS accounting frameworks.
Net cash flow is also known as cash flow.