Cash flow refers to the net change in the cash position of a company from one time period to another. This means that if a company takes in more cash than with the cash it sends out, the cash flow is considered positive. In the case, when a company has a negative cash flow, it sends out more cash that it receives. Cash flow is important to consider because of the premise that having cash puts organizations in more stable positions that ensure increased buying power.
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It is necessary to also understand the difference between cash flow and profit. While cash flow refers to the amount of money that comes and goes from the operations of a company, profit (also referred to as net income) is the amount of money left from the sales after all expenses have been subtracted (Peavler, 2019).
When companies maintain a comprehensive approach to cash flow estimations, there are seven important issues that should be monitored. They include the following:
- Sunk costs;
- Opportunity costs;
- Erosion costs;
- Synergy gains;
- Working capital;
- Capital expenditures;
- Depreciation (cost recovery of assets).
When estimating cash flow, sunk costs are important to consider because they are expenses that have been incurred (or will be incurred) despite the decision of accepting or rejecting a project. Opportunity costs are not observable or obvious; however, they result from benefits being lost at the end of a project (Brooks, 2015).
Erosion costs refer to costs that arise in the case, when a new service or product offered by a company competes with the revenue by a current product. This is important to measure because it can show whether an older product should remain due to the possibility to lose customers. Synergy gains refer to “the impulse purchases or sales increases for other existing products related to the introduction of a new product” (Brooks, 2015, p. 338).
Another indicator important for measuring is working capital, which is the cash flow result from current asset changes and liabilities. Working capital, which is the difference between a company’s assets and current liabilities, is important to measure because it is an indicator of operational efficiency. Capital expenditure is another relevant measurement because of its use in determining whether a firm should undertake a project. Lastly, depreciation should be estimated for calculating the decline in the value of goods or services.
For a new project, cash flow is imperative to estimate because it will help a company predict the amount of money expected to flow in and out of the account. It will provide an insight as to how a company can maintain its operations at the top of its financial health.
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Thus, when planning to launch a new product or service, a company needs to ensure that the new offering brought to the market will result in the increase of profit. In addition, cash flow measurements will help businesses analyze whether there is enough of it for covering the expenses associated with the introduction of a product. If it is estimated that the new product will cause more inflow of cash than expenses, it should be brought to the market.
To conclude, considering the importance of cash flow within the context of the financial health of organizations will allow companies to evaluate their ‘well-being’ and identify areas for improvement that will help reach positive outcomes and competitive advantages. In any upcoming projects, estimating the amount of money that is expected to be received is crucial for the overall decision-making process.
Brooks, R. (2015). Financial management: Core concepts (3rd ed.). London, UK: Pearson.
Peavler, R. (2019). Are a firm’s cash flow and profit different? Web.