The financial accounting term "cash flow" pertains to the rates at which revenue flows to and from a business. Cash flow represents a significant factor in determining a company's health, since it indicates how comfortably a business can fulfill its immediate financial responsibilities. Businesses with cash flow problems can encounter critical financial issues due to lack of available resources. Two methods for computing cash flow are nominal cash flow and real cash flow.
Functions of Nominal Cash Flow
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Nominal cash flow is the true dollar amount of future revenues the company expects to receive and expenses it expects to pay out, without any adjustments for inflation. In the short term and under conditions of low inflation, the amounts attributed to nominal and real cash flows are nearly identical. However, under high inflation rates, the nominal cash flow becomes greater than the real cash flow.
Applications of Nominal Cash Flow
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A major application in the use of nominal cash flow comes from anticipating future revenues and expenses. For instance, a business that wanted to anticipate its utility costs for the next five years would use the projected rate of inflation to determine the amounts it would expect to pay for water, electricity and natural gas service. However, if some unexpected factor causes these prices to rise, the erroneous forecasts would lead to faulty cash flow outlooks.
Functions of Real Cash Flow
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Real cash flow expresses a company's cash flow with adjustments for inflation. Since inflation reduces the spending power of money over time, the real cash flow shows the effects of inflation on a company's cash flow. While nominal cash flow allows business analysts to look at particular factors that constitute a company's cash flow issues, real cash flow is highly useful in showing the current state of a business's cash flow situation.
Applications of Real Cash Flow
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Real cash flow enables businesses to make well-informed comparisons of their revenue streams over time. For instance, if a business earned $1 million in revenue in 1993, that $1 million in 1993 dollars would be equivalent to $1.6 million in 2013 dollars. If the business earned revenues of $1.5 million in 2013, the real cash flow would show that the company actually suffered a noticeable drop in effective revenue over the last 20 years.
