What is the difference between cash flow and working capital?

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Cash flow and working capital are two important variables in financial analysis and business valuation.

Cash flow and working capital play an important role in managing the operations of a company. Here we show you how these two variables are related, how they are calculated and what they say about the economic performance of a company.

Are cash flow and working capital the same?

Cash flow and working capital are two important variables in financial analysis and business valuation. The two measures are similar, but not the same.

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Cash flow & working capital: Definition

Cash flow

The cash flow summarises the cash holdings of the company (account balances, cash, cheques, etc.). The cash flow indicates how much money flows out of the company and how much money flows in. If the cash flow is positive, it means that income is higher than expenditure; if it is negative, expenditure is higher than income.

The cash flow is used to finance the operational business, i.e. the income is used to cover costs and to make investments. The cash flow statement shows how high the cash flow was during the year and what liquidity a company has.

Working capital

Working capital is the difference between current assets and current liabilities. Working capital is the amount available to pay current liabilities.

Just like cash flow, working capital can be positive or negative. If it is positive, current assets are higher than current liabilities; if it is negative, current liabilities are higher than current assets.

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Now that we know the definitions of working capital and cash flow, let's look at how the two are related. Working capital represents the current assets minus the current liabilities of a company. Current assets include cash and cash equivalents, inventories and accounts receivable.

The cash flow is a flow quantity that is generated by every financial transaction and has an effect on the liquid funds of the company. If a company makes an investment, a negative cash flow is generated and the working capital decreases.

If a company takes out a loan to finance an investment, there is a positive cash flow when the loan amount is received in the company's account and a negative cash flow when the investment is paid for with it. The working capital has not changed in this case.

Cash flow & working capital: Formula

Calculating cash flow

There are different ways to calculate cash flow. It can be calculated for any period of time by directly subtracting expenses from income:

Monthly cash flow = Monthly income - monthly expenses

The operating cash flow can also be calculated from the key figures determined in the annual financial statements:

Operating cash flow = Net income + non-cash expenses - change in working capital

The operating cash flow is therefore calculated indirectly from the net income by eliminating all non-cash items and offsetting the changes in working capital against them.

How to calculate working capital from cash flow statement & balance sheet The following formula is used to calculate working capital:

Working capital = Current assets - current liabilities = Cash + cash equivalents + accounts receivables + inventory - accounts payables - wages - rent - short-term loans

The relevant figures can be found on the cash flow statement and in the balance sheet.

Cash flow & working capital ratio

Cash flow ratios

There are various cash flow ratios that can be calculated using the key figures from the cash flow statement. Liquidity is defined more and more narrowly in this context:

Current ratio = (Cash + cash equivalents + accounts receivables + inventory) / current liabilities x 100 Quick ratio = (Cash + cash equivalents + accounts receivables) / current liabilities x 100 Cash ratio = (Cash + cash equivalents) / current liabilities x 100

The current assets or parts thereof are compared with the current liabilities and a statement is made as to the extent to which the current assets would be sufficient to settle all current liabilities with them.

Working capital ratio

The working capital ratio indicates the ratio of current assets to current liabilities:

Working capital ratio = Current assets / Current liabilities

The higher this value, the higher the current assets of a company that are available to pay its current liabilities. If the working capital ratio is less than 1, this indicates that the company does not have enough short-term assets to finance its short-term liabilities, which increases the risk of default.

Cash flow & working capital: Meaning for businesses

With the definitions and formulas for cash flow and working capital and their interrelationships, we recognise that these variables are of great importance for companies.

Monitoring cash flow, working capital & accounts payable is crucial The monitoring of cash flow, working capital and accounts payable is very important to ensure the financing of operations at all times. Cash flow plays a particularly important role here, as it has a direct impact on working capital.

For everyday use, the control of cash flow is therefore of greater importance. The level of and changes in working capital are more interesting at the end of the year to assess the operational performance of the company.

The income pays the accounts payable. This means that a positive cash flow increases the working capital, from which money is subsequently withdrawn to balance the positions in the accounts payable (which in turn creates a negative cash flow).

Accordingly, there is always a cycle between cash flow and working capital, which must be optimally adjusted so that the company can pay its current liabilities and continuously increase its turnover by making investments.

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