Definition of Cash flows
Cash flows are the net variations in payments, generated by a project or company in any period of time.
Cash flows can be calculated as the difference between the income and the payments of any period of time in the maturity of a project, expressed in monetary units.
- They could be calculated using profit and loss account (PIL).
- Cash flows are used in finance to consider the value of the money along the time.
- In accountability, applying “Accrual basis principle” we focus on when the accounting transactions occur.
- In finance considering that the money has different value along the time, we should focus on when the money transaction occurs.
The statement of cash flows shows the firm’s cash inflows and outflows from:
- Operations: Generated by the business normal activities.
- Investments: in plants, equipment or in acquisitions of new businesses.
- Financing Activities: Sale of new debt or stock.
Example of Cash Flows statement
- Home Depot earned and raised more cash than it spent.
- Therefore, its cash balance increased by $902 million.
- To calculate this change in cash balance, we subtract the uses of cash from the sources:
| CFO | $4,788 |
| CFI | – $981 |
| CFF | – $2,905 |
| Change in cash balance | $902 million |
Activity 1
Would the following activities increase or decrease the firm’s cash balance?
a) Inventories are increased.
b) The firm reduces its accounts payable.
c) The firm issues additional common stock.
d) The firm buys new equipment.
Solution.-
a) Inventories are increased.
An increase in inventories uses cash, reducing the firm’s net cash balance.
b) The firm reduces its accounts payable.
A reduction in accounts payable uses cash, reducing the firm’s net cash balance.
c) The firm issues additional common stock.
An issue of common stock is a source of cash, so increase it.
d) The firm buys new equipment.
The purchase of new equipment is a use of cash, and it reduces the firm’s net cash balance.
En colaboración la Dra. Inés Martín de Santos.