Trickling cash flows: Your economic health is in question!

You must have heard the term “cash flow” being bandied about by economists and wondered what it actually signifies. Cash flows are very important economic parameters for determining the health of an economy. Trickling cash flows indicate that your economic health is in question.

The term “cash” actually refers to the physical availability of spend-able cash. “Flow” defines how the cash moves from one entity to another. The cash flow determines the health of an economy. It is the life blood and any blocks in the life blood will cause the economy to seize up and die. It is for this reason that economists are very concerned about cash flow in the current scenario when recession is slowing down the flow of cash in the economy.

So how does one determine how much of cash is available for spending in an economy? It is important to understand that every entity—businesses and individuals—create a cash flow.

If you are employed, you receive and spend your salary. You may save something out of it. This causes a flow of cash from one entity (you) to another (business). You may also receive some interest from your savings or investments or you may borrow money from your bank to spend. The cash again flows from your bank to you. Income from dividends or other kinds of property is also cash that flows to you. So you generate a flow of cash by spending the cash that flows to you.

Similarly business entities that manufacture goods or services too have cash flows from operations, investments and financial activities. They make purchases of raw material; invest in their employees and in the machinery causing cash flow to these different entities within the business cycle. They receive sales proceeds, money from shareholders or they receive payments from debtors causing the business to be flush with cash that they can spend on operating, investing or other financial activities. If there is no inflow of cash there will be no outflow of cash.

Therefore, a Cash Flow Statement is a statement that is related to both the Income Statement and the Balance Sheet. It defines 1. the ability of the entity or the economy to generate cash or cash equivalents for its various activities and 2. is the indicator of solvency (otherwise known as liquid assets). The rate of flow of cash in the economy is taken as a parameter in defining whether the economy is healthy, vulnerable, struggling etc. It helps in forecasting business difficulties and possible bankruptcy.

The recession has triggered off cash flow constraints in many economies of the world. Businesses went into an economy drive and decided to restrict cash flow out of the business. People were dismissed so that their salary could be saved in the business. People who lost their job, no longer had the cash to spend. So there was no flow of cash from individuals to business entities. This process created blocks in cash flows and generated fears that the economies so affected would seize up and die. The “bail out packages” that were announced by various Governments were efforts to clear out the cash flow blocks and ensure that the there is a constant and smooth flow of cash in their economies.

So cash flow is a very important parameter in determining whether an economy is coming out of the recession or not – and the same indicators apply to your business.