1. What is Cashflow? Terms Related to Cashflow
1.1 What Does Cashflow Mean?
Cashflow is a concept in finance to describe the movement of cash/cash equivalents into and out of an organization, individual or project over a specific period of time, usually daily, weekly, monthly, or annually. Cashflow represents how money is generated and spent in the course of business or personal finance. What does Cashflow mean? Cashflow consists of two main parts: Cash Inflow: This is the money you receive, including revenue from sales, collections from customers, interest from investments, new loans, and any money generated or poured into your finances. Cash Outflow: This is the money you pay out, including business operating expenses, debt payments, employee salaries, rent, and any other expenses you make. Cashflow management is an important part of financial management, because it helps ensure that you have enough money to meet your financial commitments and keep your business or personal finances running smoothly. If cashflow is not managed carefully, it can lead to cash shortages and difficulty in paying debts or maintaining business operations.
1.2 Some terms related to Cashflow The terms related to Cashflow that you need to understand are:
Free Cash Flow (FCF): an indicator that measures a company’s ability to generate cash after deducting all expenses and investments necessary to maintain operations and growth. FCF is often used to assess the ability to pay dividends, reduce debt or invest in new projects.
Net Cash Flow (NCF): the difference between the total cash in and the total cash out over a specific period of time. It indicates that if the total cash in is greater than the total cash out, then you have a positive amount of cash, meaning you have surplus cash after all financial transactions. If the total cash out is greater than the total cash in, then you have a negative amount of cash, meaning you are experiencing a cash shortage.
Cash Flow Statement: The Cash Flow Statement is one of the three major financial statements, along with the Income Statement and the Balance Sheet. The Cash Flow Statement describes the cash flows in and out of a business over a specific period of time. It is divided into three main sections: operating activities, investing activities, and financing activities. This report helps readers understand how cash moves through a business, which can provide important information for financial management and decision making.
See also:
What is Net Income? Examples and simple calculation of net income
2. Analyze cash flow indicators Cash flow ratio analysis To better understand Cashflow indicators, let’s analyze with JobsGO.
2.1 DSCR Index The DSCR is an important metric in finance, especially when assessing the ability of a business or project to repay its debt. It calculates the ratio between operating profit or net income and the amount you have to pay each month to repay the debt (including interest and principal). The DSCR is calculated using the formula:
DSCR = Operating Profit or Net Profit / Monthly Cash Needed to Service Debt A DSCR greater than 1.0 indicates that the business or project has the ability to repay its debts. If the DSCR is below 1.0, this means that the profits are not enough to repay the debts and there is a risk of debt. Evaluators usually want to see a higher DSCR, especially when considering large loans or project investments. See also: What is net profit margin? Profit margin formula
2.2 Free cash flow index Free cash flow is an important measure of a business or project’s ability to generate cash after deducting the fixed costs and investments required to maintain and grow operations. The formula for calculating FCF is: Free Cash Flow = Operating Cash Flow – Investment Expenses This ratio is often used to assess a company’s ability to generate cash available to pay dividends, reduce debt, or invest in new projects. If FCF is positive, it means that the company is generating cash after meeting all its financial and investment commitments.
2.3 Unlevered free cash flow ratio Unlevered free cash flow is a variation of FCF that does not account for the use of debt. It focuses on the ability of a business or project to generate cash from operating and investing activities, independent of debt. This can be useful when you want to know the ability of a business or project to generate cash without being affected by existing debt or potential debt. The formula for calculating unlevered free cash flow is: Unlevered free cash flow = Earnings before interest, taxes, depreciation and amortization – Total capital expenditures – Total working capital expenditures – taxes
3. Cash flow forecasting techniques Cash flow forecasting techniques There are many cash flow forecasting techniques that businesses and investors can use to estimate future cash flows.
Here are some common techniques:
3.1 Net cash flow forecast A net cash flow forecast is the process of estimating the future cash flows into and out of an organization or project. This includes identifying the expected sources of cash inflows, such as sales or investment revenues, and the expected cash outflows, including operating and investment expenses. A net cash flow forecast helps a business or individual understand its expected financial position and plan for it.
3.2 Free cash flow forecast Free cash flow forecasting is the process of predicting the ability to generate cash after deducting necessary expenses and investments. It involves estimating future profits, fixed costs, and investment projects. Free cash flow forecasting helps measure the financial strength of a business or individual, determining the ability to pay dividends, reduce debt, or make investments.
3.3 Economic cycle forecasting Business cycle forecasting involves predicting changes in economic activity globally or in a particular industry. This includes predicting the phases of the economic cycle, such as expansion, recession, or depression. Business cycle forecasting can help businesses or investors adjust their financial and investment strategies based on the overall economic situation.
3.4 Regression Forecasting Regression forecasting is a statistical method for predicting the value of a dependent variable based on independent variables. It is commonly used in finance to estimate the relationship between financial factors and cash flows, such as the effect of stock prices or interest rates on cash flows. Regression forecasting provides a theoretical approach to predicting and evaluating the impact of independent variables on future cash flows. See also:
What is financial management? Job description of a financial administrator
4. How to manage cash flow Cash flow management helps maintain stable personal or business finances. You can refer to some effective ways to manage cash flow below:
4.1 Divide each specific item To effectively manage cash flow, management needs to focus on assigning each amount of money specifically. This includes setting goals for each amount of money, such as cash coming in from the business, money to buy new equipment, money to pay off debt, or money to save. By assigning each amount of money to a specific goal, you can track and control your cash flow more effectively.
4.2 Have a plan for income and expenditure An important part of managing your cash flow is creating a budget. Create a budget for your business or personal finances. A budget helps you set specific income and expenditure goals for a specific period of time. It allows you to track your progress and identify any discrepancies between your plan and reality.
4.3 Have risk contingency Cash flow can be affected by risk factors such as market fluctuations, changes in customer behavior or emergencies such as natural disasters. Therefore, managing cash flow requires risk planning. This involves identifying potential risks and developing contingency plans to deal with them. By planning for risks, you can minimize negative impacts on cash flow, protect your solvency and keep your business running smoothly. See more: 3 steps to help you manage your personal finances effectively
5. Instructions on how to plan cash flow for businesses Guide to cash flow planning for business Cash flow planning for a business is an important part of financial management to ensure a stable financial situation and predict the ability to repay debts, invest, and develop. The cash flow planning process includes 4 steps as follows:
5.1 Cash inflow forecast Cash flow forecasting requires a clear identification of the business’s sources of income. This step involves gathering information about current and future income. First, identify your main revenue sources, such as sales, projects, or investments. Then, use historical data and market information to forecast future revenue sources. Consider growth, seasonality, and economic cycles when creating your forecast.
5.2 Cash outflow forecast Cash flow forecasting requires identifying and listing your business’s expenses. You should consider all of your hidden and fixed expenses, including operating expenses, rent, salaries, interest, taxes, and other expenses. In particular, you should consider seasonal fluctuations and customer payment terms to create a cash flow forecast for each period.
5.3 Determine the ending balance/shortage Once you have forecasted both cash inflows and cash outflows, you need to sum them both to determine the ending cash surplus or deficit. By comparing the total cash inflows and the total cash outflows, you will know the surplus or deficit at the end of each planning period. If the total cash inflow is greater than the total cash outflow, the business will have surplus cash, that is, there is excess cash to use for specific financial goals. Conversely, if the total cash inflow is less than the total cash outflow, the business will have a cash shortage, requiring corrective measures.
5.4 Proposed solutions If you have extra cash, consider how you can use it effectively. You can invest it to earn interest, pay down debt to reduce interest costs, or create a reserve fund for emergencies. This will help optimize your returns and ensure financial stability. In case of cash shortage, you need to consider solutions to adjust cash flow. Cutting costs, increasing revenue, finding additional capital through borrowing or raising capital from investors may be necessary measures to balance cash flow and ensure stable business operations. Understanding what cashflow is and knowing how to forecast, analyze, and manage it can be a decisive factor for the success and sustainability of a business or personal finances. Hopefully the above article by JobsGO will be useful to you.
