Defining Cash Flow

Over the past month, I’ve heard a few discussions regarding cash flow. When discussing the topic I would notice that they would couple the definition of cash flow with a few other financial terms. Though they were saying the right things they didn’t fully understand what cash flow really is. So, I thought I’d take the time to write this article defining cash flow for you all. That way you have an actual definition to go off of. I will even add an example of cash flow toward the end to give you a better idea of what it is.

What is Cash Flow?

So, what is cash flow anyways? Cash flow in simple terms is money moved from one bank account to another. Where this gets kind of confusing is when people talk about positive cash flow or free cash flow (FCF). Cash flow is a very important part of your business. This is how shareholders (or investors) determine the value of your company. It helps them decide whether to keep investing (or initially investing) in your company or not.

To determine positive cash flow you, to dumb it down, have to have more money coming in than you do going out during a period of time. Which is where every company dreams to be.

Difference between Cash Flow and Revenue/Profit?

Now, what makes Cash flow different than revenue/profit? The difference is businesses take in money from sales as revenues and then spend money on expenses. The business may also receive income from interest, investments, royalties, and licensing agreements. They may also sell products on credit, expecting to actually receive the cash owed at a late date.

Now that we have defined that. The difference is revenue is the money you are bringing in through sales, profits are what you make after expenses. While cash flow is the money actually hitting and leaving your bank account. If you are to make $100K in revenue but it won’t hit your bank account till the next month but you have to pay $100K in expenses this month, you have a negative cash flow. That is all you really need to know regarding the difference between cash flow and revenue/profit. Defining cash flow can be quite wordy so let’s bring up an example.

Examples of Cash Flow

I know that most of the article is pretty much an example of cash flow but I still feel like it’s necessary to hit the nail on the coffin. In order to aid my example, check out this article by business insider regarding Tesla and Rivian. In the article, Elon Musk says that Rivian’s true test is having high production and break-even cash flow.

To understand what that means you have to put your microeconomics hat on. With high production, you are making vehicles and you need to have demand for those vehicles. So, if there are high demands and people are putting in orders and you send them the cars you now have what is called earnings potential. Those buyers can buy the car in straight cash for 100% of the value or pay you through a loan. Depending on how the car companies do their deals they’ll have to wait days till after the car is made to get their money for the cars that they are producing.

If they are able to get cash within 30 days and they have to pay their bills within 60 days they are now in a positive cash flow position. That’s the simplified version but that’s essentially how it works. In order to calculate Tesla’s free cash flow (FCF), you have to look at their operating net cash (liabilities minus cash) and subtract that from their capital expenditures (or expenses).

Takeaways

This article is not supposed to be deep with knowledge but is meant for defining cash flow. What most people see as an easy concept. Is actually a concept that people confuse and mix up all the time. The more you know the more you can accomplish. It also makes you look less like an idiot and more like an Average Genius! Ha, get it!

If you like this article check out my other investing articles as well!