What is cash flow?

Cash flow is one of the main indicators of the financial status of a company that needs to be known

Cash flow is the net amount of cash and cash-equivalents going into and out of a business. Let's take a look at the information this indicator can offer us about the financial state of our business or company.

A business or a manager being able to read a balance sheet or an income statement account is absolutely essential nowadays, even if financial affairs are not part of their skills set. However, this is still not enough. They must also be able to adapt it to reality. And the reality is liquidity, cash. So we must ask the following question: what is cashflow?

This is a term that continues to be used heavily, even though it has waned given the advance of others such as EBITDA. In any case, the important thing is to understand the why and how it is used, as well as its limitations. We will focus on these points rather than going into greater detail on classifications and methods of calculation, which would greatly divert us from the core issues.

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Accounting and cash

One of the main problems when performing accounting analysis is reconciling it with our financial reality. It is common to find companies that, at first glance, appear to be in excellent financial health, but actually have empty cash boxes. In times of crisis, beyond profits, special attention is paid to the company's liquid assets, which is when the concept of cashflow comes into question.

Cashflow is the cash that enters and leaves the business. moving into and out of a business. At school, we are normally taught the following:

Cashflow: Profit + amortizations + provisions

As we can see, cashflow is an indicator of profits in a given period, after amortizations and provisions. Why does this happen? If we know the answer to this question, we will begin to understand the task ahead of us and the scope of the issue.

Amortizations are a cost that does not involve a cash output. In accounting terms, amortizations cause a decrease in the result of the financial year, however, they do not involve disbursement. The cash, liquid assets, remain in place. The same applies to provisions.

As we can begin to imagine, through the cashflow we try to specify our financial resources, the cash that a company is able to generate in a given period, which is of primordial importance. But it is not that easy.

Why talk about cashflow?

Going beyond profits and starting to talk about cashflow can be very useful. It is a first step to know our financial health, its progress and evolution. And we can use it to answer our doubts about whether we will be able to meet our payment commitments.

Are we generating enough cash to meet our providers? Or our creditors? What will be the impact of an investment in the planned cash flow?

When we start to consider these questions, looking at how to balance our needs with our possibilities, the various kinds of cashflow will become clear: the operation, from investments or divestments and that resulting from financial operations...

In contrast, cashflow by destination needs to be studied: stockholders, reinvestments, debt repayment, etc.

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Limitations on calculating cashflow

The formula we have given to calculate cashflow is the best known and most used, called accounting cashflow. It can be interesting, especially for comparative purposes across different financial years, but it has a significant limitation and is determined using the accrual rule.

The key is that it calculates accounting profit as cash, but that is not actually the case. Having invoiced a sale and calculated the earnings does not imply that we have actually received this money. If everything goes well, it is likely that it will be a deferred sale, and therefore, part of the sales (and profits) from a financial year will remain as outstanding balance in the next financial year. However, if things go badly, we may not receive payment for these deferred sales, after having calculated them as extra money in our pockets.

It is not a matter of forgetting cashflow, it is a matter of understanding its limitations and of using different ways to calculate it, understanding their limitations. It is possible that for certain purposes we may use the classic accounting cashflow, and for others we might have to use direct or indirect methods of estimating our cashflow (on-site study of cash, performance of the Sources and Applications of Funds, etc.).

The limitations of accounting generate the need for different instruments to test current and planned levels of liquid assets, and therefore to know how to manage them.

Tools to control the financial status of your company

At BBVA, we know how important it is to manage your company properly. To help, we offer our BBVA One View service, a financial aggregator that gives you all the information on your accounts, credit accounts and cards at a glance, regardless of the bank. A good way to get an overview of your cash flow from a single platform and in real time. All this with BBVA's highest standards for security and privacy.

Discover the possibilities it offers, from online banking for BBVA Net Cash, through the website or the app, or by going to www.bbvaoneview.com.

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