Cash Flow: What It Is, How It Works, and How to Analyze It

What is cash flow?

Cash flow is the movement of money into and out of a business over a period of time. When inflows exceed outflows, net cash flow is positive; when outflows exceed inflows, it is negative. Cash flow is a key indicator of liquidity and a company’s ability to meet obligations, invest, and return capital to shareholders.

Key takeaways

• Cash flow tracks actual cash movement, not accounting accruals.
• Net cash flow = total cash inflows − total cash outflows.
• The cash flow statement breaks cash movement into operating, investing, and financing activities.
• Positive cash flow improves flexibility; persistent negative cash flow can be a warning unless it reflects strategic investment.

Formula and basic calculation

Net Cash Flow (NCF) = Total Cash Inflows (TCI) − Total Cash Outflows (TCO)

Understanding cash flow

Cash flows come from sales receipts, collections on receivables, interest or investment income (inflows), and payments for operating expenses, purchases, debt service, dividends, or capital expenditures (outflows). Because cash flow reports actual cash movement, it complements the income statement and balance sheet when assessing financial health and short-term solvency.

The cash flow statement

The cash flow statement reconciles a company’s beginning and ending cash balances and is organized into three sections:
* Operating activities — cash generated or used by core business operations (also called operating cash flow).
* Investing activities — cash used for or generated by buying/selling long-term assets and investments (e.g., PP&E, acquisitions).
* Financing activities — cash flows related to capital structure (issuance/repayment of debt, equity transactions, dividends).

Types of cash flow

• Cash flow from operations (CFO or OCF): Cash generated by regular business activities. It shows whether operations produce enough cash to cover operating expenses.
• Cash flow from investing (CFI): Cash used for or produced by investments in assets or securities. Large negative investing cash flow can simply mean the company is investing for growth.
• Cash flow from financing (CFF): Cash received from or paid to capital providers (debt and equity). It reveals how a company funds itself and returns capital.

How to analyze cash flows

Use the cash flow statement together with the income statement and balance sheet. Common analysis approaches and metrics include:
* Operating cash flow trend — indicates sustainability of core operations.
* Free cash flow (FCF) — cash available after operating expenses and capital expenditures: FCF = CFO − Capital Expenditures. Measures the cash a company can use for dividends, debt paydown, or reinvestment.
* Cash flow margin — operating cash flow divided by sales; gauges cash conversion of revenue.
* Cash flow coverage ratios — e.g., cash flow to debt, interest coverage using cash flow.
* Valuation ratios — price-to-cash-flow (P/CF) compares market price to operating cash flow per share and can be useful when earnings are depressed by noncash charges.

Example

A large retailer reported a net decrease in cash when investing in property, plant, equipment, and acquisitions while also using cash in financing activities (debt repayments and dividends). A negative net cash flow in a period can reflect heavy investment or changes in capital structure rather than operational distress; context and trends matter.

Explain it like I’m 5

Think of cash flow like your bank account. Money you deposit (paychecks, gifts) is cash inflow. Money you spend (groceries, toys) is cash outflow. If more goes in than out, your balance grows (positive cash flow). If you spend more than you get, the balance falls (negative cash flow). Businesses work the same way.

Cash flow vs. revenue vs. profit

• Revenue: the total amount earned from sales (may include sales on credit).
• Profit (net income): revenue minus expenses, often affected by noncash items like depreciation.
• Cash flow: actual cash entering and leaving the company. A profitable firm can have poor cash flow and vice versa.

Free cash flow and why it matters

Free cash flow (FCF) is the cash a company generates after paying for operating expenses and capital expenditures. FCF indicates how much cash is truly available to reinvest, pay dividends, reduce debt, or fund growth, making it a crucial measure of financial flexibility and valuation.

When and why companies report cash flows

Public companies report cash flow statements as part of their standard financial reporting. Investors, lenders, and managers use these statements to assess liquidity, operational health, and capital allocation decisions.

Bottom line

Cash flow shows the real-time cash health of a business—how money is generated and used. Evaluating cash flow alongside earnings and balance sheet metrics provides a fuller picture of a company’s financial strength, flexibility, and long-term prospects.