The concept of cash flow can be defined in different manners. Some people feel that it is fit to define cash flow as an income through sales or a revenue through any economic activity or any expenditure for the organization. It must be noted that inward cash flow does not include many incomes such as a credit sale of goods or income due but not received.
A cash flow must be strictly financially liquid cash, or finances that can be stored in a bank account or in the form of currency. Any financial statement, that shows an inward or outward flow of cash is a proof of cash flow. It must be noted that profits, due payments, and other factors related to credit are not included under the domain of cash flow.
Cash Inflow and Outflow
The concept of cash flow can be broadly divided into two categories, namely the inflow and outflow. The cash inflow or inward cash flow or just cash flow, is generated as a result of financing, ventures, and sales. The cash outflow or onward flow of cash, is seen as a result of purchases, investments, salaries, and administrative expenditures.
The importance of a statement indicating cash flow was realized in the wake of the 2007 recession cycle. Business organizations realized the importance of evaluating and analyzing cash flow, and started regular audits of cash outflows and inflows. The study of inflow and outflow plays an important role in general financial planning and financial management.
How is Cash Flow Important?
There are significant advantages of inward and outward flow of cash in any business or organization, which are:
The biggest importance of cash flow is that the business or organization tends to have an assured income irrespective of the outside economic condition. Many business corporations have a very well-balanced and uniform inward and outward cash flow.
Ensures Timely Payment
The uniform and assured cash flow, in both the directions, ensures two principal payments, namely, the salaries of employees are paid on time and installments of all loans are made on time. This safeguards the trust of employees and upholds the credit rating.
The analysis of cash flow ensures that the business is not investing finances in the wrong avenues, and investments already made are paying off well. This ratio is often termed as the return over asset ratio.
Saves Unnecessary Expenditure
The use of inward and outward cash flow, prevents all unnecessary expenditure such as piled up interest, late payment charges, etc.
As the inflow and outflow of cash is on time, you are left with adequate free and liquid finances, which you may invest in time-bound instruments and securities.
These kinds of flows can be put down into what is known as cash flow statement, which is like a balance scale. This statement that shows the inward and outward balances, helps us to locate unnecessary expenditures, and income that is due but not received.