Importance of Cash Flow

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, which is also known as inward cash flow or just cash flow is generated as a result of financing, ventures and sales. The cash outflow which is also known as onward flow of cash is seen as a result of many factors such as 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 have realized the importance of evaluating and analyzing cash flow, and have started regular audits of cash outflows as well as inflows. This study of inflow and outflow tends to play an instrumental 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:

• Income Assurance: 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.
• Return Ratio: 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 return over asset ratio.
• Keeps You Out of Debt: The timely cash inflow plays a very instrumental role in keeping you out of debt, as a timely inflow of cash prevents you from taking small loans.
• Saves Unnecessary Expenditure: The use of inward and outward cash flow, prevents all unnecessary expenditure such as piled up interest, late payment charges, etc.
• Timely Investments: 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.

The importance of evaluating cash flow can be summarized in a very simple manner, by comparing it with a balance scale. When we measure anything with a balance scale, we immediately realize the comparative differences between the heavier and lighter. 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.