For a simple understanding of Net Cash Flow let's decipher each element of this phrase:
- Net – implies a balance (difference)
- Money – speaks for itself that it is money
- Flow – movement:receipts (income) and expenses (expenses)
Thus, we have that the net cash flow is nothing but the balance of money between all their receipts and all their expenditures.
The keyword of ALL, which determines the purity of the cash flow, i.e. takes into account all types of activities!
Any economic process on the basis of which the assets (balance sheet) of an economic entity are built is based on 3 types of activities:
- Current or in other words operating, which forms short-term assets (investments) - raw materials, materials, etc.
- Investment, which forms long-term assets – buildings, structures, equipment, programs, etc.
- Financial, which serves the first two types.
The essence of finance is in the work of the enterprise: to provide "blood circulation" of its main "organs" of current and investment activities.
The main reason for the work of any commercial organization is to create assets that will work for the growth of its well-being.
To earn income, it is necessary to invest in assets - to buy equipment (long-term non-current assets) and raw materials, energy, labor resources, etc. (short-term current assets). Financial activity forms them either at the expense of own funds (if any), or at the expense of liabilities (loans, loans).
Each type of activity has its own balance, which in total determine the net cash balance in the whole organization.
Let's look at a simple example of how the net cash flow of an enterprise is calculated, taking into account all types of activities.
Operating balance
The company buys raw materials, pays for electricity, wages, taxes, etc. expenses are an OUTFLOW.
It incurs expenses in order to produce a product, sell it and get money (revenue) for it - this is an INFLUX.
The difference between the INFLOW of current activities and its OUTFLOW is the balance of current or, in other words, operating activities.
For reference:
It is necessary to understand that the current activity balance is not profit, but in many ways its value depends on it.
There are two reasons here - this is a temporary deviation from the paid-received and the accounting policy of the organization.
In order for the operating balance to be as close as possible to the amount of profit calculated, it is necessary:
- minimize the time gap between payments for production costs and receipts of revenue from it. (decrease in the norms of the stock of current assets).
- build an accounting policy of an organization that does not contribute to attributing the current result to its balance sheet or writing off the balances of previous periods to it.
Balance of investment activity
An enterprise needs to buy equipment in order to produce products. Payments related to the acquisition of long-term assets of the organization are an OUTFLOW.
And the receipts associated with the sale of these non-current assets (for example, sold, unnecessary equipment or used) is an INFLUX.
The difference between the INFLOW of investment activity and its OUTFLOW is its balance.
Balance on financial activities
In fact, financial activity, taking into account the current situation on operational and investment activities, or closes "holes" (deficits on the net balance) due to the forced additional attraction of money (loans, loans, etc.) or accumulates them (own funds).
Financial activity should always, at a minimum, reduce the net balance of the organization to zero.
So, the receipt of funds associated with the lack of a positive balance from current and investment activities generates an INFLOW of financial activity, and payments related to settlements on all accrued and newly formed liabilities generates an OUTFLOW on it.
In general, financial activity is an important lever, a support in the functioning of both the current and investment activities of the organization.
Here is a simple tabular example. We will evaluate and build the cash flow of the organization. Let's analyze how all three types of activities are linked when calculating the net cash balance of an enterprise.
Let's say that the company purchases equipment for the 1st and 2nd month of its activity and pays for the construction and installation work performed. The balance of investment activity is (-) 25 thousand.$ for the 1st month and (-)7 thousand. Since there is no positive balance on operating activities for these two months, the company is forced to finance investments at the expense of credit and borrowed funds (inflow of financial activities for the same amounts), thereby reducing net cash flow to zero for these periods.
In the 3rd month, the company invests in current assets, purchasing raw materials, paying for energy, wages, taxes. In other words, it provides inventory and work in progress. There is no revenue yet. The negative balance for this type of activity (-) $72 thousand. is also closed with loans (inflow from financial activities + $72 thousand).
From the 4th month of its activity, the company begins to receive revenue already and, taking into account current payments (outflow), the balance on operating activities already has + 7 thousand $, which from the 5th month allows covering the negative balance on financial activities formed by repayment of previously taken loans.
Thus, taking into account the prevailing cash flows for all types of activities, the company will be able to accumulate $ 15.9 thousand on its current account by the end of the 12th month. This is the accumulated net cash flow balance for the period under review.
When calculating the accumulated net cash flow, it must always be remembered that there can never be a negative balance!
Well, for example, you can't have a minus of 5 rubles in your wallet. That is, if the need is greater than the possibilities, then you will either exclude it, or you will find additional money to cover it in the form of a loan, loan, etc. Similarly in financial relations organizations, enterprises and other business entities.
What is net Cash Flow – how to evaluate and calculate it! – Something like that!
