Operating cash flow, investment and financing. Measures of financial performance

If you've ever wondered how companies manage to stay afloat and how they decide when to invest or finance, then you're in the right place. I'm going to take you on a journey through the fascinating world of "cash flow", a vital concept in economics and business management. But what exactly is cash flow? Read on to find out, and be sure to read to the end, where I'll reveal how this concept is central to FRA courses at IE University.

Table of contents

1. What is Cash Flow in the company?

2. What types of cash flows exist and what do they consist of?

3. How to calculate Cash Flow using the indirect method?

4. Why is Cash Flow important in a company?

5. Cash Flow in the FRA (Financial Reporting & Analysis) course at IE University

6. Summary table

What is cash flow in the company?

Cash flow is a measure of financial performance that shows the amounts of money flowing in and out of a company during a given period. Essentially, it it assesses the health of a company or projectIt essentially assesses the health of a company or project, identifying profitability problems and providing a path for optimization.

This essential financial statement shows cash inflows and outflows during a given accounting period, allowing the creation of future forecasts. It is divided into three sections: operating cash flow, investing cash flow and financing cash flow.

Cash flow is one of the indicators of a company's financial health.

What types of cash flows exist and what do they consist of?

There are 3 types of cash flows that we can find in the accounting of any company. Operating cash flow, investment cash flow and financing cash flow:

Operating cash flow

The operating cash flow is an important financial indicator, as it reflects the amount of cash a company generates through its regular business operations at a specific time. This flow does not reflect profit or loss, but rather the net cash balance resulting from the company's main activities.

Its relevance lies in its ability to reveal the company's liquidity and, therefore, its financial health. In general, it includes variations in current assets and liabilities, and unfortunately, many companies do not pay enough attention to it, risking liquidity problems despite having sales and profits.

Investment flow

On the other hand, investment cash flow relates to the variations in a company's fixed assets, generated by its collections and payments related to investments in long-term tangible assets, intangible assets and other long-term financial instruments. These may include share purchases, capex expenses related to real estate, acquisition of machinery, among others.

This indicator is closely linked to the company's investment capacity, i.e. how money is managed and used by managers to achieve better returns.This indicator is closely linked to the company's ability to invest, i.e. how the money is managed and used by the managers to achieve better returns. Investors, wanting to multiply their capital, value how these aspects are managed to gain confidence that their investment will be safe.

Flow of financing

Financing cash flow, also known as financing cash flow, is a key concept in finance that focuses on the cash inflows and outflows arising from a company's financial activities. Specifically, it evaluates the movement of money linked to the raising and return of financial resources, such as loans, issuance of shares or bonds, as well as the repayment of debts or distribution of dividends.

This indicator, distinct from operating and investing cash flow, reflects exclusively transactions related to a company's financing, reflects exclusively transactions related to a company's financing and mainly affects long-term debt and equity accounts. It thus provides a clear view of financial decisions and their impact on the organization's cash flow.

How to calculate cash flow using the indirect method?

Now that you know the types of cash flows, you might be wondering how can I calculate cash flow? One of the most common methods is the indirect method.

This is based on the accrual method, starting from the net income obtained from the income statement and making adjustments to cancel the impact of entries that do not involve cash outflows or inflows during the period.

The calculation of cash flow distinguishes the good financial performance of companies.

The procedure for calculating cash flow can be summarized in the following formula:

1. Operating Cash Flow (Operating Cash Flow):

2. Income for the year

3. +Depreciation

4. +/- Loss/gain on sale of assets

5. +negative changes in current assets

6. -positive changes in current assets

7. +positive changes in current liabilities

8. -negative changes in current liabilities

9. Investing Cash Flow (Investing Cash Flow):

10. +Sales of fixed assets

11. -Fixed asset acquisitions

12. Financing Cash Flow (Financing Cash Flow):

13. +Increase in long-term liabilities

14. -Decrease in long-term liabilities

15. +Equity increase

16. -Decrease in Equity

17. Net cash flow:

18. Increase/decrease in cash = operating cash flow+investment cash flow+financing cash flow.

19. Finally we can calculate cash flow:

Final Cash = Cash Flow + Cash Beginning of Fiscal Year

It is important to note that only those items that involve cash inflows and outflows are included in the cash flow, discarding any items that do not meet this condition.

Each of these steps involves a series of specific calculations based on the different items in the company's accounts.Each of the terms in this formula is therefore a summary of more detailed operations.

However, this formula provides you with a solid and understandable framework for calculating cash flow using the indirect method.

Why is cash flow important for a company?

The answer is simple: a company may be profitable on paper, but without adequate cash flow, it may face liquidity problems and eventually run out of funds. This can lead to an inability to meet its financial obligations, which in turn can lead to insolvency. Good cash flow management is essential for a company's survival and growth.

Cash flow in the FRA (Financial Reporting & Analysis) course at IE University.

Now that you know more about cash flow and its relevance in the business world, you may be wondering where you can apply this knowledge.

This is where IE University's FRA course comes into play. This course addresses the subject of cash flow in a comprehensive manner, allowing students to understand its importance and how to use it to make sound financial decisions.

Cash flow is usually studied after the midterm as one of the last topics, and the questions that deal with it include questions related to the three cash flows analyzed in this article: operating, investment and financial cash flows.

Summary table

What is Cash Flow in the company?	Cash flow is a measure of financial performance that shows the amounts of money flowing in and out of a company during a given period. It is divided into operating, investing and financing cash flow.
What types of cash flows exist and what do they consist of?	Operating Cash FlowCash Flow: reflects the cash generated by regular business operations. Investment Cash FlowCash Flow from Investments: it is related to investments in fixed assets. Financing Cash FlowFocused on transactions affecting long-term liabilities and equity.
How to calculate Cash Flow using the indirect method?	The indirect method is used, which involves adjustments to the net income obtained from the income statement. Specific calculations are made based on items in the company's accounts.
Why is Cash Flow important in a company?	To avoid liquidity problems and meet financial obligations. Without adequate cash flow, you may face financial difficulties.

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