Cash Flow

In business money exchanges hands, while some businesses might be more cash intensive than others, in the long run it is important for all of them to have a positive cash flow. That is every company must have more cash going into its pocket than out. It is very important to understand at this point that cash inflow is not the same as profit and vice versa.

While the sole purpose of any company's existence is to create profit, it cannot possibly survive without a positive cash flow as cash flow sustains productivity, employment and wealth creation, or in other words, cash flow keeps the shop running. As long as a business has a positive cash flow it can stay in business even if it sustains overall losses, on the other hand, if a business is profitable but has negative cash flow it will have to shut down as it will not be able to cope up with its daily expenses. In essence cash is king.

Given how important cash flow is it is obvious that companies must perform a cash flow analysis before undertaking a new project or even to assess a division of the company. To provide a certain rationale and a basis to the analysis there are a few assumptions that we make:

1. Stand Alone Principle: Treat the project as an entity independent of the company and look into its cash flows from that perspective.

2. Think Incrementally: How is the company's cash position affected when we undertake the project v/s when we don't

3. Focus On Cash: Only consider the flow of money, receivables should not be considered as cash inflow, if anything they are places where your cash is deployed and hence are outflows.

4. Opportunity Cost: Opportunity costs represent the benefits an individual, investor or business misses out on when choosing one alternative over another. Ask yourself, can this resource be used elsewhere? Will this project affect any other existing ones? What if i were to sell the resources instead?

5. Excluding Sunk Cost: In the process of making your decision you will incur costs like market research, auditing etc. These costs are not included in the cash flow of the project as this is money spent before the idea was ready.

6. Exclude Funding Costs: Funding costs like interests and dividends are adjusted for in the expected rate of return or the discount rate and hence should not be explicitly accounted for in cash flow of a project.

By making a cash flow statement we can see if the project is profitable and also apply methods like return on investment, payback period and net present value to see if we should proceed with the project. Again one must ensure that the company maintains a positive cash flow in order to stay in business because as always, cash is king.