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Cash Flow

Cash flow is a funny thing.  Not funny ha ha, because that would be weird, but funny in the sense that it might appear to be redundant.  I mean, you are already measuring income, so what's the difference?

Well, my young pup, the difference is that not all of the money that goes into or out of your company is related to the goods and services your company produces.  For example, if you sell an investor 50% of your company for $250,000, you must account for that money. But the proceeds from sale of stock aren't revenue1.

Likewise, that depreciation from the Lear Jet didn't actually go away as cash, so if you want to know how much money you REALLY made, you need to add it back in.

WHAT'S EBITDA?

Glad you asked.  Cash flow is sometimes called EBITDA or Earnings Before Interest, Taxes, Depreciation and Amortization.  Frankly, I think interest and taxes should be left in, but who am I? What what we are trying to get at is "is this company making money?"  And as you are beginning to realize, there are a hundred different answers to that question, so you choose a metric and stick to it.  Some folks use Free Cash Flow, which is usually Cash From Operations, though some folks use FCF and EBITDA interchangeably.  Those people can mow my bat-lawn, Robin.

You account for all transactions that aren't related to operations on the Cash Flow statement.

Here are other things that are accounted for on the cash flow statement:

depreciation
buying large, long-term assets like real estate or equipment
borrowing money and paying back loans
paying dividends

Here's our cash flow statement:


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Cash flow is actually pretty simple.

Cash From Operations: What you do is simply start with you profit line and keep taking off non-cash stuff until you have Cash From Operations.  In this model, there is only one non-cash item, so you just put it back.

Cash From Investments:  This is where you account for stuff you are buying, like Lear Jets and whatnot.  There is an argument to be made that my Lear Jet payments are actually a  financing and I should put them in the Cash From Financing section, but it helps me think of them as a depreciable asset to put them in the Cash From Investing section, so that's where they go.  The actually accounting treatment may be different than how we model it.

Cash from investments will show up on your balance sheet as increases and decreases (if you sell an investment) in your long-term assets.

Cash From Financing:  Here's where you put your equity infusions, your borrowings and your debt payments.  If someone gives you $1.2 million, you put it here.  If you pay off a $30K loan, you put it here.  Just imagine to yourself whether to money is going in or coming out.  If it's going in, you are increasing your cash. If it is going out, you are decreasing your cash.

Cash from Financing will show up on your balance sheet as changes in equity (if you sell or buy shares) or changes in liabilities (if you borrow or pay off debt).  Dividend payments, BTW, go as cash outflows under Cash From Financing and they reduce equity (or really they reduce retained earnings which we'll see in the balance sheet section).

 

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1Proceeds is plural.

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