No business can ignore its cash flow. Monitoring your cash flow is like monitoring your pulse – it’s a crucial health check for your business. It’s crucial to understand the measures of cash flow, which suites best for your business.
What is Cash Flow?
Jack Welch, former chairman and CEO of General Electric once said, "Number one: cash is king." You could say this is very true for a small business. Cash flow keeps every business healthy and strong.
There are different ways to measure cash flow. Each has its strengths and weaknesses, depending on the nature of your business and your operational goals. Here are six ways your outsourced accounting and bookkeeping services should consider.
1. Free Cash Flow To Invest
Free cash flow (FCF) represents the cash that a company has available after capital expenditures, such as mortgage payments and equipment, and is one of the most important and common metrics for measuring cash entering and exiting a company. Free cash can be used to enlarge product and service lines, pay off debts and allow businesses to pursue other activities that help increase the company’s value to shareholders.
Companies should start by finding their EBIT, to calculate free cash flow with the below formula
FCF = EBIT x (1-Tax Rate) + Depreciation + Amortization – Change in Net Working Capital – Capital Expenditure
2. Cash Flow From Operations
Cash flow from operations (CFO) brings money accumulated as a result of normal, continuous business activities. With respect to CFO, “business activities” includes earnings before interest and taxes (EBIT), but it does not include long-term capital. To calculate cash flow from operations, start by finding the business’ EBIT with the below-given formula
CFO = EBIT + Depreciation – Taxes
3. Cash Flow From Financing Activities
Cash flow from financing activities takes into external activities of accounts that enable businesses to increase its capital and pay off debts and, by extension, can be used to reveal a company’s financial strength to investors. Possible financing activities may include, issuing cash dividends and stocks and refinancing. To calculate your company’s cash flow from financing activities, use the below-given formula:
Cash Received From Issuing Stock – Cash Paid as Dividends and Re-Acquisition of Stock
4. Discounted Cash Flow To Value Stock
Discounted cash flow (DCF) measurements are vital for evaluating investment prospects with the inclusion of future cash flow projections against current capital costs.
DCF=CFt /( 1 +r)^t
USES:
Discounted cash flow (DCF) helps determine the value of an investment based on its future cash flows.
The present value of expected future cash flows is arrived at by using a discount rate to calculate the discounted cash flow (DCF).
If the discounted cash flow (DCF) is above the current cost of the investment, the opportunity could result in positive returns.
Companies typically use the weighted average cost of capital for the discount rate, as it takes into consideration the rate of return expected by shareholders.
The DCF has limitations, primarily that it relies on estimations on future cash flows, which could prove to be inaccurate.
5. Cash Flow From Investments
Your statement of cash flows has three sections:
cash flow from financing
cash flow from operations
cash flow from investments.
Cash flow from investments includes when you buy or sell equipment, real estate or securities such as stocks and bonds. It also includes when you make loans to other firms.
6. Levered Cash Flow
A free cash flow that a company has left after fulfilling its debts is known as Levered cash flow (LCF). Determining LCF is tough to stockholders, as it tells them how much cash is available for distribution and investment purposes.
If the cash paid out for debts exceeds incoming cash flow, a company may have bad levered cash flow even if its OCF is positive. You can find your business’ levered cash flow with the below-given formula:
Unlevered free cash flow – Interest + Mandatory Principal Repayments
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