Cash flow analysis is one of the most important pieces of financial information for a firm. Before approving a loan banks analyze the cash flow of firms to decide whether the companies have the ability to repay a loan. As well, the cash flow analysis before an investment project is crucial in order to decide whether the project should be undertaken or not. If the banks ignore this type of analysis, among others, you wind up with the problem seen in the current credit crisis around the globe.

What is cash flow? Simply, the cash flow is the difference between the amount of dollars that enter the firm and the amount of dollars that exit the firm.

There are different types of cash flow, but for the purpose of this course it is enough if we treat all of them equally. Basically the cash flow in our examples will summarize the total cash result from all the transactions a firm is involved in during a year. The activities that bring cash are considered sources of cash and they result in cash inflows (revenues). The activities that spend cash are called uses (or applications) of cash. They will result in cash outflows (costs). The difference between cash inflows and cash outflows during a period will be the net cash flow (or sometimes simply cash flow).


There are many types of investments that companies can do:

• Financial investments: start with a cash outflow (security price) which is known; revenues are also known usually.

• Equity investments: the initial price is known but the future revenues are unknown usually, compared to financial investments (e.g.: shares vs. bonds). Thus cash flows are difficult to estimate.

• Real investments: building a plant, starting a business, etc. The future cash flows can be estimated and are used to determine whether the project is profitable or not. However these cash flows are subject to risk.

• Government investments: they involve certain costs and benefits for different groups of population. The flows of costs and benefits are compared to determine the usefulness of the projects using the so-called cost-benefit analysis.

In order to evaluate any investment project we must know the flows of costs and benefits. Generally, any project starts with some costs (cash outflows) and revenues follow later (cash inflows). Many analyses tools can be found in basic Excel packages for the student or small business.

This post is part of a series of articles on cash flow analysis. Visit our cash flow analysis page to find a summary of each method.