In my first post on the Tech-Finance divide I looked at the time value of money in relation to investment, and how it influences getting ideas off the ground in larger formal organisations.
Now I thought we could take a brief look at Cash Flow and further expand our communication tool-set as a technologist..
As the saying goes “Revenue is vanity, profit is sanity, cash is king”.
On the other hand Warren Buffet notes that cash is “not king, it just sits there and never does anything”.
So what is the deal with Cash Flow, and as a techie why do you care?
Cash flow is basically the amount of cash (or cash equivalents) coming into, and going out of a business. Ok, but what does that consist of? It is basically the value of the assets in a company that are either cash, or can be converted to cash immediately. In this case ‘immediately” usually means 90 days and, an asset. Cash coming in is predictably called cash ‘inflow’ and money spent is ‘outflow’. You might hear this referred to as ‘liquidity’.
In essence, cash flow on a statement shows how much money has been used in making investments, and money generated from those investments over a specific period of time. These can include marketable securities, which are assets that can be converted or ‘liquidated’ to cash quickly.
This contrasts with say, the investing activities of a company which looks more at the purchasing of long-term assets over a specific period of time. It also make sense that ‘property, plant and equipment’ (PP&E) used for productive purposes, are harder to quickly turn to ready cash. Essentially you are trying to differentiate between what you have done, and what you have done recently. Cash flow focuses on the ‘recently’.
Let’s anchor this with some reference-able terminology, as the reason for any summary term is to broker an agreement on common language on which to base a formal conversation (a baseline if you will). Here are a few terms around cash flow:
Cash: Cash in everyday terms is readily available money, usually a currency with coins, bills, currency notes etc. You can have this literally in your pocket for exchange in low volumes, or stored somewhere like a deposit account. The defining feature of these accounts is that they are “demand” deposits from which you can withdraw at any time, immediately, with no need to notify the institution in advance.
Cash equivalents are usually short-term investments, where the investment duration is less than 90 days maximum. The currency amount of cash equivalents must be known, with a known market price, and not subject to fluctuations. Basically something that can be converted to comparable cash with a stable market price in short order.
There are three main types of Cash Flow, which are relatively easy to understand:
Operating cash flow (or cash flow from operations), looks at the cash generated or taken up from the normal operating activities of a business. Operation of its primary business activities.
Investing Cash Flow – which looks at all the purchases of stuff, or capital assets, and all the investments a company has chosen to make – maybe into other business opportunities.
Financing Cash Flow – looks at the cash flow an organisation has coming in or going out relating to any debt it has issued, as well as equity, and any payments. All the proceeds from this stuff!
So far so good, but what is free cash flow? I have heard that this is important?
Free cash flow tries to find out what the actual net cash inflow of a business is. You can work it out as follows: Free Cash Flow = Operating Cash Flow (CFO) – Capital Expenditures
Why is this important?
In general if your free cash flows (FCFs) are growing, then this can often be an indication that earnings will increase. If you are growing revenue, improving efficiency, reducing cost or eliminating debt (among other things), then you increase the odds that earnings will increase, and in turn maybe share value. On the flip side, if free cash flow is getting smaller, it could indicate that earnings growth may struggle to keep growing. As with a lot of things, it is not always that clear cut. For example, you could be investing for growth in the future through capital expenditure which would hit your near term free cash flow, but increase your profits and revenue down the line.
Another thing to take into consideration is the form of cash flow, i.e. whether it is Levered or Un-levered (leverage just being another term for debt).
Levered Cash Flow, is the money an organisation had after is has fulfilled its financial obligations, or in other words, its debt (outstanding debt or regular payments you must make..)
Un-levered Cash Flow is the money an organisation has before fulfilling its financial obligations, or before debt. Importantly this is gross free cash flow, not net.
Again, having low Levered cash flow could be an indication that the company has a fragile cash buffer after fulfilling its financial obligation and it may be harder secure borrowing (financing) from a lender in order to make capital investments for growth. From this you may have worked out that it does not necessarily mean disaster. If your Levered free cash flow is negative you could just be waiting for large investments to start making a meaningful impact. Either way it gives you information to assess where your company is today and where it might be based on investments and projections, and can be held to account over time.
But I am a technologist, what has this got to do with me?
If you are a technologist who has ever had to promote your solution or idea, sometimes you simply cannot fathom why others do not see the value in the technology. It could be something as seemingly obvious as a roof on a house to keep the rain out, so the value is implied.
Now, it is obvious to anyone that you can’t really do without a roof where the weather is even slightly unpredictable, you just need a roof! But… in a world where not everyone understands a) what a roof is b) what it does and c) why it is important, then quantifying the investment (and showing other paybacks – e..g solar panels that pay for energy and reduce other operating costs etc.) and then relating this to a company’s financial aims (including cash flow) is crucial. Technologists often inhabit a world where what is obvious to them is not so obvious to others.
A roof costs money, and we all know the cautionary phrase about not fixing the roof while the sun is shining, which in turn shows how an obvious priority is not always assured. In reality, without a roof the contents of your building and all the economic value of the items therein may be destroyed by persistent rain, which can even affect the foundations of the building. Even here there is a cost / benefit analysis that might need explaining. If it means investing in a roof to enable you to get all the benefits of everything within the building (and the value they bring), then if you can quantify this expenditure as enabling future growth, it can also negatively affect near term cash flow (investment in a non-current asset). This, of course, could be absolutely fine if the benefit is quantified appropriately.
I may have stretched the roof analogy somewhat, but one aim as a technologist is to try to communicate the value of your solution in quantifiable terms. By understanding the financial playing field (of which cash-flow terminology and attitudes towards cash-flow are a part) you further arm yourself with the ability to distill benefits in the most relevant terms for your audience’s understanding.
In a department where numbers rule, this can be the difference between genuine interest and apathy.
asbtechblog 