Cash flow measures how much cash a company takes in versus how much it expends. More cash coming in than going out means the cash flow is positive. If the opposite is true, the cash flow is negative.
A business is considered healthy when its cash flow is positive for a prolonged period of time. Even profitable businesses, however, can experience short periods of negative cash flow.
When a business has a negative cash flow for an extended period of time, it typically becomes insolvent and may need to declare bankruptcy.
Banks look at cash flow to help decide how much money they are willing to lend a company. They calculate EBITDA (earnings before deducting interest, taxes, depreciation and amortization) to measure cash coming in, and then deduct all contractual debt payments of principal and interest (cash expended) to determine the net cash flow.
More about cash flow
A comprehensive measure of cash flow is displayed in a company’s statement of changes in financial position. It pulls data from its income statement and balance sheet to show all the sources and uses of cash and provides a net figure for the year.
Using ABC Co.’s income statement, we can calculate its cash inflow (EBITDA) as follows:
Net profit + interest + taxes + depreciation + amortization
$20,000 + $8,000 + $10,000 + $5,000 = $43,000
From a banker’s perspective this means ABC Co. has $43,000 in cash flow available to service its debts.