Among the main methods of business valuation, the ones that are certainly to be counted are the so-called financial methods, based on the discounting of cash that a company is able to generate. It is important to know how to determine, in a fast and simple way, the cash flow created by a company during a specific period, from official data expressed in the budget.
Cash flow indicates the amount of cash that a company is able to generate in the course of carrying out its business. Before going on to examine the methods to determine the extent of this flow, it is necessary to make a brief introduction on the stage of the life cycle that happens in the company when you are calculating the cash flow.
In fact, in the early stages of the life cycle (development) it is not uncommon to come across negative cash flows since the company is mainly engaged in making investments. In the later stages, however, and particularly in the mature phase, the stabilization of sales and the reduced need for investments allow an expansion of the company’s ability to generate cash.
To calculate the cash flow generated by a company in a given period (usually coinciding with the calendar year) there are two methods.
The most straightforward method is the so-called direct method by which the cash flow is determined by the difference between revenues and costs money realized and/or incurred in a given period (ie income and expenses that have caused a movement in cash and the cash equivalents of the company). If, for example, a company had revenues of money for 1000, while supporting monetary costs for 860, the course of the expected cash flow generated by the company amounts to 140 (1000-860).
Because the items expressed in the budget are not classified according to their monetary or not, you can reach the same result by using the so-called indirect method.
With the method in question, you can calculate the cash flow from the results of the period (profit or loss) by adding the same amount of non-monetary costs (depreciation, provisions and impairment losses, etc..) and subtract the amount of non-cash revenues (revaluation of securities or real estate).
Let us look at a simple example to clarify the operation of the indirect method. Suppose that a company has closed the year with a profit of 100 and has depreciation and amortization of 45, provisions of a figure of 15 and write-ups of 20. The cash flow generated in the period will be 140. (100+45-15+20= 140)
As mentioned above, this method, certainly more complex than the direct method, is used to determine the cash flow from the data of the budget, which is often the only document available to analysts outside the company.