3/5/2020 Cash Flow

BUSINESS CORPORATE FINANCE & ACCOUNTING

Cash Flow
By WILL KENTON | Updated May 5, 2019

What is Cash Flow

Cash flow is the net amount of cash and cash-equivalents being transferred into and out of a
business. At the most fundamental level, a company’s ability to create value for shareholders
is determined by its ability to generate positive cash flows, or more specifically, maximize
long-term free cash flow.

BREAKING DOWN Cash Flow

Assessing the amounts, timing and uncertainty of cash flows is one of the most basic
objectives of financial reporting. Understanding the cash flow statement – which reports
operating cash flow, investing cash flow and financing cash flow — is essential for assessing a
company’s liquidity, flexibility and overall financial performance.

Positive cash flow indicates that a company's liquid assets are increasing, enabling it to settle
debts, reinvest in its business, return money to shareholders, pay expenses and provide a
buffer against future financial challenges. Companies with strong financial flexibility can take
advantage of profitable investments. They also fare better in downturns, by avoiding the
costs of financial distress.

Even profitable companies can fail if operating activities do not generate enough cash to stay
liquid. This can happen if profits are tied up in accounts receivable and inventory, or if a
company spends too much on capital expenditure. Investors and creditors, therefore, want
to know if the company has enough cash and cash-equivalents to settle short-term liabilities.
To see if a company can meet its current liabilities with the cash it generates from operations,
analysts look at debt service coverage ratios.

But liquidity only tells us so much. A company might have lots of cash because it is
mortgaging its future growth potential by selling off its long-term assets or taking on
unsustainable levels of debt.

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Free Cash Flow

To understand the true profitability of the business, analysts look at free cash flow (FCF). It is
a really useful measure of financial performance – that tells a better story than net income —
because it shows what money the company has left over to expand the business or return to
shareholders, after paying dividends, buying back stock or paying off debt.

Free cash flow = operating cash flow - capital expenditures - dividends (though some
companies don’t because dividends are viewed as discretionary).
= Trésorerie d’Exploitation – Immobilisations – Dividendes
For a measure of the gross free cash flow generated by a firm, use unlevered free cash flow.
This is a company's cash flow before taking interest payments into account and shows how
much cash is available to the firm before taking financial obligations into account. The
difference between levered and unlevered free cash flow shows if the business is
overextended or operating with a healthy amount of debt.

Real World Example

Below is a reproduction of Walmart Inc (WMT) cash flow statement for the quarter ending on
April 30, 2015. All amounts are in millions of U.S. dollars.

Cash flows from operating activities:  

Consolidated net income 3,283

(Income) loss from discontinued operations, net of income taxes —

Income from continuing operations 3,283

Adjustments to reconcile consolidated net income to net cash provided by

 
operating activities:

Depreciation and amortization 2,319

Deferred income taxes (159)

Other operating activities 239

Changes in certain assets and liabilities:  

Receivables, net 782

Inventories (1,475)

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Accounts payable (319)

Accrued liabilities (919)

Accrued income taxes 695

Net cash provided by operating activities 4,446

   

Cash flows from investing activities:  

Payments for property and equipment (2,203)

Proceeds from the disposal of property and equipment 68

Other investing activities 22

Net cash used in investing activities (2,113)

   

Cash flows from financing activities:  

Net change in short-term borrowings (741)

Proceeds from issuance of long-term debt 43

Payments of long-term debt (915)

Dividends paid (1,579)

Purchase of Company stock (280)

Dividends paid to noncontrolling interest (69)

Purchase of noncontrolling interest (70)

Other financing activities (84)

Net cash used in financing activities (3,695)

   

Effect of exchange rates on cash and cash equivalents (14)

   

Net increase (decrease) in cash and cash equivalents (1,376)

Cash and cash equivalents at beginning of year 9,135

Cash and cash equivalents at end of period 7,759

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Let's begin by seeing how the cash flow statement fits in with other components of Walmart's
financials. The final line in the cash flow statement, "cash and cash equivalents at end of
period," is the same as "cash and cash equivalents," the first line under current assets in the
balance sheet. The first number in the cash flow statement, "consolidated net income," is the
same as "income from continuing operations" on the income statement.

Because the cash flow statement only counts liquid assets, it makes adjustments to
operating income in order to arrive at the operating income that flows in as cash and cash
equivalents. Depreciation and amortization appear on the balance sheet in order to give a
realistic picture of the lifetime value of assets. Operating cash flows, however, are considered
at face value, so these adjustments are reversed. Meanwhile, assets that are not in cash form
are deducted: inventories, for example. Investments that appear as assets on the balance
sheet are deducted, because these were presumably paid for in cash. The statement also
takes debt repayments, dividends and foreign exchange impacts into account. (For related
reading, see "Cash Flow and the Effect of Depreciation")

The main takeaway is that Walmart's cash flow was negative (a decrease of $1.38 billion) for
this quarter, but that is not necessarily a bad thing as long as it retains sufficient reserves to
handle short-term liabilities and fluctuations in its business. (For related reading, see "Is It
Possible to Have Positive Cash Flow and Negative Net Income?")

Related Terms
Deciphering the Acid-Test Ratio
The acid-test ratio is a strong indicator of whether a firm has sufficient short-term assets to cover its
immediate liabilities. more

Operating Cash Flow (OCF) Definition

Operating Cash Flow (OCF) is a measure of the amount of cash generated by a company's normal
business operations. more

Cash Flow From Operating Activities (CFO) Definition

Cash Flow From Operating Activities (CFO) indicates the amount of cash a company generates from its
ongoing, regular business activities. more

What the Debt/EBITDA Ratio Tells You

Debt/EBITDA is a ratio measuring the amount of income generation available to pay down debt before
deducting interest, taxes, depreciation, and amortization. more

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