Cash flow: Overview, definition, and example
What is cash flow?
Cash flow refers to the movement of money into and out of a business or individual’s financial accounts over a specific period. It includes all incoming revenue from sales, investments, or other income sources, as well as outgoing payments for expenses, liabilities, or investments. Cash flow is a critical indicator of an organization’s financial health, as it shows whether the company can cover its operating expenses, invest in new opportunities, or pay off debt.
Why is cash flow important?
Cash flow is important because it ensures that a business has enough liquidity to meet its immediate financial obligations. Without sufficient positive cash flow, even a profitable company could face financial difficulties. Negative cash flow, in particular, can lead to the inability to pay bills, employee salaries, or service debt, potentially leading to insolvency. Managing cash flow is crucial for businesses to maintain operations, plan for growth, and stay financially solvent.
Understanding cash flow through an example
Consider a retail business that generates revenue by selling products. If the business earns $100,000 in sales during a quarter but has expenses, such as supplier payments, rent, and wages, amounting to $90,000, its cash flow for that period would be $10,000. This positive cash flow means the business has enough funds to reinvest, save, or pay down debt. If the business had $110,000 in expenses instead, it would experience negative cash flow, indicating potential cash shortfalls.
Example of how cash flow may be referenced in a contract
Here’s how a reference to cash flow may appear in a financial agreement:
"The Borrower agrees to maintain a positive cash flow of at least $50,000 per quarter, as demonstrated by the quarterly financial statements, and agrees to provide the Lender with a copy of the statement within 30 days after the end of each quarter."
Conclusion
Cash flow is a vital metric for businesses, as it reflects the company’s ability to sustain operations, manage debts, and invest in future growth. A solid understanding of cash flow is essential for making informed business decisions. Businesses must carefully monitor and manage cash flow to ensure they can meet obligations and avoid financial difficulties.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.