What is cash flow from assets?

Understanding cash flow from assets

Cash flow from assets (CFFA) represents the total cash generated by a business’s assets within a specific period. It reflects its operational efficiency and financial health. Cash flow from assets focuses only on cash generated by operations, excluding external financing activities, such as selling stocks.

CFFA includes three types of cash flows:

1. Cash flow from operations. This component encompasses the net income from business operations after covering all expenses. It includes non-cash expenses such as amortization and depreciation, offering a comprehensive view of operational profitability.
2. Changes in working capital. Reflecting the net change in inventory, accounts receivable and accounts payable over the measurement period, changes in working capital play a crucial role in CFFA. A decrease in working capital signifies cash generation, while an increase indicates cash utilization.
3. Changes in fixed assets. This component refers to the net change in fixed assets before accounting for depreciation effects. Fixed assets, enduring beyond a financial reporting period, are essential for business operations. Depreciation, a non-cash expense, represents the allocation of long-term asset costs over their useful life, influencing CFFA.

Understanding CFFA provides insights into a business’s operational efficiency, financial stability, and ability to generate cash internally, which is critical for sustainable growth and strategic decision-making.

Why is it important to track cash flow from assets?

Calculating CFFA provides a better understanding of a company’s financial health, operational efficiency, and strategic effectiveness, making it a critical metric for stakeholders and investors alike. Here are the main reasons why you should track CFFA:

1. Insight into operational effectiveness. By focusing on cash flow generated from core operational assets while excluding peripheral activities, cash flow from assets clearly assesses a company’s ability to use its assets efficiently. This is invaluable for internal stakeholders and investors seeking transparent insights into the company’s primary functions.
2. Liquidity assessment. Positive CFFA indicates a company’s ability to generate sufficient cash to meet immediate obligations, reducing reliance on external funding. For lenders, this metric reflects the firm’s capacity to repay debt, potentially leading to lower lending risks and more favorable lending terms.
3. Indicator of management competence. Consistent positive cash flow reflects effective leadership and strategic asset utilization, highlighting management’s competence in generating cash. Conversely, negative or declining cash flow may raise concerns about operational strategies, warranting attention from business owners to address potential issues.
4. Strategic capital allocation. CFFA guides strategic capital allocation decisions by helping management identify assets that yield strong cash flows versus those that do not. This information aids in informed decisions regarding investments, divestitures, or asset replacements, facilitating accurate budgeting and forecasting.
5. Benchmarking and competitive analysis. Comparing cash flow from assets across companies within the same sector is a benchmarking tool that allows stakeholders to evaluate a company’s performance relative to its peers. This comparative analysis aids in investment decisions and provides insights into competitive positioning within the industry.

In summary, CFFA serves as a compass for navigating the financial landscape of a business, offering invaluable guidance to stakeholders, investors, and management in assessing financial health, operational efficiency, and strategic direction.

How to calculate cash flow from assets

The calculation of CFFA requires specific metrics. Here’s a guide to help you figure out your company’s CFFA:

1.    Determine your operating cash flow (OCF)

The first step is calculating your company’s operating cash flow (OCF), that is, cash flow from operations. To determine your company’s OFC, refer to its statement of cash flows and find the section “Cash flow from operating activities” or “Cash flow from operations.” The final figure in this section represents your operating cash flow, which indicates the cash generated or used in the business’s core operations.

2.    Calculate your net capital spending (NCS)

Move to the “Cash flows from investing activities” section on your statement of cash flows, which may also be labeled as “Cash flow from investing.” Identify the amount spent on capital assets, often listed as “Purchases of property, plant, and equipment,” and subtract any proceeds from selling capital assets. The resulting figure is your net capital spending (NCS), which indicates the net cash used for or received from investments in the company’s long-term assets.

3.    Determine your change in net working capital (𐤃 NWC)

Determine your company’s change in net working capital (𐤃 NWC) by comparing the balance sheets from two consecutive periods, such as fiscal quarters or years. Calculate the NWC for each period by subtracting current liabilities from current assets. Then, subtract the earlier period’s NWC from the later period’s NWC to find the change in NWC.

CFFA Formula

Once you have calculated your company’s operating cash flow, net capital spending, and change in net working capital, you can calculate your CFFA using the following formula:

CFFA = Operating Cash Flow (OCF) – Net Capital Spending (NCS) – Change in Net Working Capital (𐤃 NWC)

By applying this formula, you can determine the total cash generated or used by the company’s assets during the specified period, providing valuable insights into its financial performance and operational efficiency.

How to increase your cash flow from assets

Increasing CFFA is essential to improve liquidity, fund expansion initiatives, and fortify their financial resilience, and various strategies can enhance CFFA and contribute to long-term sustainability. Optimizing operations is a fundamental approach to increasing CFFA. By streamlining processes, businesses can minimize waste and inefficiencies, ultimately reducing operational costs and enhancing cash flow. This may involve implementing lean manufacturing practices, improving supply chain management, and minimizing downtime in production.

Efficient management of accounting-related processes also plays a significant role in boosting CFFA. Accelerating the collection of accounts receivables through early payment discounts and proactive credit policies can expedite cash inflows. Additionally, monitoring inventory levels and implementing just-in-time inventory systems can reduce holding costs and optimize cash utilization.

Another strategy to increase CFFA is to sell underutilized assets that are not essential to core business operations, providing an immediate cash influx. Continuously evaluating and reducing unnecessary expenses, managing debt efficiently, and revising pricing strategies can also enhance cash flow from assets.

Furthermore, ensuring asset diversification mitigates risks associated with overreliance on a single asset or market segment. By diligently monitoring and optimizing these areas, businesses can incrementally improve their CFFA, positioning themselves for sustained growth and resilience in the face of financial uncertainties.

Summary

• Cash flow from assets (CFFA) is the total cash generated by a company’s assets, excluding cash flow from financing activities.
• CFFA focuses on cash generated from operations and includes three types of cash flows: operations, changes in working capital, and changes in fixed assets.
• Calculating CFFA provides insights into a company’s operational efficiency, financial stability, and ability to generate cash internally.
• To calculate CFFA, determine operating cash flow (OCF), net capital spending (NCS), and change in net working capital (𐤃 NWC), and use the formula: CFFA = OCF – NCS – 𐤃
• Strategies to increase CFFA include optimizing operations, efficient management of accounting processes, monitoring inventory levels, negotiating favorable terms with suppliers, increasing asset utilization, selling underutilized assets, evaluating costs, managing debt efficiently, revising pricing strategies, and ensuring asset diversification.

Sources:

Investopedia. Cash Flow: What It Is, How It Works, and How To Analyze It.

GoCardless. What Are Cash Flow Assets? 

Indeed. A Guide To Cash Flow From Assets.

altLINE. How To Calculate Cash Flow From Assets.