What is Cash Flow?
April is Financial Literacy Month and our goal is to help you raise your money IQ. In this series, we'll tackle key economic concepts -- ones that affect your everyday finances and investments -- to help you make smarter choices with every dollar decision you face. Stick with us, and you'll end April financially smarter than you were when the month began.
Here's a vital concept to understand: cash flow.
The meaning of the term varies depending on context. In the accounting world, for example, it refers to the change in a company's cash level over a specific period of time. If a company's cash level rises during that period, it's exhibiting positive cash flow. If it shrinks, negative cash flow.
When investors study companies to see if they might be good fits for their portfolios, they may assess "free cash flow." That reflects a company's cash flow from its operations after it pays all its expenses. Free cash flow can be viewed as the lifeblood of a company.
Negative free cash flow means a company is burning through its cash -- a la J.C. Penney (JCP), Sears Holdings (SHLD), and Radio Shack (RSH), all of which have recently been sporting negative free cash flow.
While negative free cash flow can be viewed as a red flag in the investing world, it's not necessarily a portent of doom. It all depends on what the company is spending its money on. Consider Netflix (NFLX), for example. Its free cash flow recently turned negative, but it has been investing heavily in its business, enlarging its catalog, and creating original programming, such as the well-received "House of Cards."
Cash flow in our lives
The cash flow concept isn't just useful for companies. It can also be applied to personal finances and can give you a better handle on how you're doing money-wise.
To assess your personal cash flow, grab your bank account statement and jot down the cash you had on hand at the end of the past few months or quarters. (If you have multiple bank accounts and/or coffee cans stuffed with money, include those as well.) A glance at those sums will reflect whether you're building cash value or shedding it.
Big or growing cash totals mean you have more opportunities to deploy those sums -- perhaps socking some in an emergency fund, or adding to an IRA, or paying down debt.
Your cash flow doesn't represent your total financial health, though. That's a topic for another day. After all, you might have a modest amount of cash in the bank but no debt, a robust stock portfolio, solid retirement savings, and a big chunk of equity in your house.
Tracking your cash flow, however, can be a big eye opener.
Corral your cash and see which way it flows
To make your assessment of your cash flow most meaningful, dig deeper into the details to see where your money is coming from and where it's going.
For many people, the main (or only) input is salary. There are myriad ways that money flows out of our accounts, though.
If you charge most of your expenses, you'll be able to research your spending habits relatively easily via your credit card statements. If you often pay by cash, consider carrying a notebook for a few months and jotting down each payment you make.
By looking closely, you might spot some ways that cash is trickling away needlessly, such as via a gym membership you never use, or a telephone landline that's redundant given your cellphone's role in your life.
If this is beginning to sound like budgeting, you're not imagining things. Budgeting is a great way to get a firm grip on your spending, and to help ensure that you're taking care of your needs and wants without living beyond your means.
Becoming a better financial thinker and decision maker doesn't have to be hard. Simply learning about some simple economic concepts like cash flow is a great way to start.
More money terms to know:
Sunk cost
Opportunity cost
Compound interest
See all money terms to know
Motley Fool contributor Selena Maranjian owns shares of Netflix. The Motley Fool recommends Netflix. The Motley Fool owns shares of Netflix and RadioShack.
