Cash Flow

Cash flow is the difference between cash received and cash paid in a period and shows how much money has actually come into a business. Unlike profit it contains no non-cash items such as depreciation or changes in provisions and is therefore less dependent on accounting options. The cash flow statement divides it under IAS 7 and the German standard DRS 21 into three sections: cash flow from operating activities, from investing activities and from financing activities. Together with separately reported effects such as exchange rate changes, these sections explain the change in cash and cash equivalents during the reporting period. The operating section is usually presented indirectly, starting from net income with adjustments for non-cash items and for changes in working capital.

The umbrella term should be distinguished from the two measures covered separately in this glossary: operating cash flow denotes only the operating section. A commonly used free cash flow measure deducts capital expenditure from it. For the cash flow available to all capital providers used in valuation, interest and tax effects must be treated consistently. Anyone referring to cash flow without a qualifier therefore means different things depending on context, which is why contracts and valuations should always name the specific measure. In diligence, cash flow is set against EBITDA over several years, because a persistent gap between the two points to working capital absorption, high maintenance requirements or earnings components with no cash behind them.

Loan agreements tie their covenants to cash flow measures, because interest and amortisation can only be serviced out of payments. IAS 7 also permits a direct presentation, which reports receipts and payments by category and is easier for a reader to follow. The indirect method nevertheless prevails in practice, because it can be derived from the accounting records without additional analysis. For valuation the measure is therefore the starting point of the discounted cash flow method, while multiple-based approaches build on earnings measures such as EBITDA or EBIT.