Cash-flow test - Law Dictionary (2024)

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Cash-flow test - Law Dictionary? ›

The cash-flow test assesses the ability of a company to pay its debts (or sell its assets fast enough to pay its debts) as they become due and payable.

This doesn't have to be complicated – all you really need is to input forecast sales with the timing of forecast receipts and against that enter known payments due. A simple cash flow forecast will highlight when you may have a problem in paying suppliers on time.

Both cash flow and balance sheet insolvency tests are important to assess a company's financial health. There are a couple of key differences between the pair: Balance sheet insolvency compares assets and liabilities. Cash flow insolvency compares available cash flow to meet outgoings on time.

If its liabilities are greater than its assets then the company can be said to be balance sheet insolvent. The cash flow test looks at whether the company can meet its outgoings in full as and when they fall due.

TWO SOLVENCY TESTS UNDER COMMON LAW

The cash-flow test considers the ability of a company to pay its debts (or liquidate assets fast enough to satisfy its debts) as they become due and payable.

Home » Cash Flow Testing. A form of cash flow analysis involving the projection and comparison of the timing and amount of cash flows resulting from economic and other assumptions.

A cash flow analysis is the examination of the cash inflows and outflows of a business to determine a company's working capital. It looks at a certain period of time for different activities, including operations, investment, and financing.

The Cashflow test is simply whether the company can pay its debts when they fall due for payment. If you are paying your trade creditors at 90 days plus but the trading terms are 30 days, your company could be insolvent. The Balance Sheet test is whether the company's assets are exceeded by its liabilities.

A solvency analysis involves up to three tests: the “balance sheet” test; the “un- reasonably small capital” test; and the “ability to pay debts” test. In a preference action only the balance sheet test applies; any (or all) of the tests may be at issue in fraudulent transfer litigation.

What items are not covered under a cash flow statement? ›

As for the balance sheet, the net cash flow reported on the CFS should equal the net change in the various line items reported on the balance sheet. This excludes cash and cash equivalents and non-cash accounts, such as accumulated depreciation and accumulated amortization.

The three core financial statements are 1) the income statement, 2) the balance sheet, and 3) the cash flow statement. These three financial statements are intricately linked to one another.

The balance sheet shows a snapshot of the assets and liabilities for the period, but it does not show the company's activity during the period, such as revenue, expenses, nor the amount of cash spent. The cash activities are instead, recorded on the cash flow statement.

Solvency is the ability of a company to meet its long-term financial obligations. When analysts wish to know more about the solvency of a company, they look at the total value of its assets compared to the total liabilities held. An organization is considered solvent when its current assets exceed current liabilities.

Wrongful trading is the act of continuing to trade after the point which the company director knew - or ought to have known - that the company was insolvent and that there was no reasonable chance of the company avoiding insolvent liquidation. Wrongful trading is an extremely serious matter.

A solvency ratio indicates whether a company's cash flow is sufficient to meet its long-term liabilities and thus is a measure of its financial health. An unfavorable ratio can indicate some likelihood that a company will default on its debt obligations.

One can conduct a basic cash flow analysis by examining the cash flow statement, determining whether there is net negative or positive cash flow, pinpointing how the outflows compare to inflows, and draw conclusions from that.

Free Cash Flow = Net income + Depreciation/Amortization – Change in Working Capital – Capital Expenditure. Operating Cash Flow = Operating Income + Depreciation – Taxes + Change in Working Capital. Cash Flow Forecast = Beginning Cash + Projected Inflows – Projected Outflows = Ending Cash.

Subtract your monthly expense figure from your monthly net income to determine your leftover cash supply. If the result is a negative cash flow, that is, if you spend more than you earn, you'll need to look for ways to cut back on your expenses.

Subtract your required investments in operating capital from your sales revenue, less your operating costs, including taxes, to find your free cash flow. The formula would be: Sales Revenue – (Operating Costs + Taxes) – Required Investments in Operating Capital = Free Cash Flow.