The types of cash flow"Cash flow" is used in several senses. Some of the types below are parts of the cash flow statement (in Brazil, the DFC, Demonstração dos Fluxos de Caixa); others are ways of preparing it; and others are planning and valuation tools. It is worth knowing each one so as not to mix them up.Operating cash flowOperating cash flow records the inflows and outflows of money linked to the company's main activities, that is, the sale of products and services and everything needed to carry it out.The focus is on operating movements: receipts from sales, payments to suppliers and for inventory, salaries, taxes on operations, rent, subscriptions for systems and equipment, among others.It does not include purchases of machinery, real estate or stakes in other companies (which are investments), nor loans taken out or contributions and withdrawals by the partners (which are financing).Direct cash flowCash flow under the direct method shows the gross amounts that came into and went out of cash, grouped by nature: how much was received from customers, how much was paid to suppliers, to employees, in taxes and so on.Because it records only money that actually moved, items that do not affect cash, such as depreciation, do not appear in it.It is the most intuitive way to see where the money came from and where it went.Indirect cash flowCash flow under the indirect method starts from the net income reported in the accounts and adjusts it until it reaches the cash generated by operations.Because it relies on accounting data, it is used more by accountants and analysts than by managers in day-to-day work, who tend to follow cash with the direct method.It uses the income statement (DRE, Demonstração do Resultado do Exercício) and the balance sheet (BP, Balanço Patrimonial): expenses that did not leave cash are added back to profit, and the changes in receivables, inventories and payables are taken into account, to explain why profit for the period (accrual basis) differs from the cash generated (cash basis).Free cash flowFree cash flow measures the money left over after paying all operating expenses and the investments needed to maintain (and expand) the business. In simplified form: operating cash flow − investments in fixed assets − increase in working capital needs. It shows the company's ability to sustain itself, grow and reward its partners or investors.Projected cash flowProjected cash flow is used in financial planning for a future period. It lets managers anticipate cash needs and be prepared for variations, such as months with shortfalls or surpluses of money.To estimate projected cash flow, you need to analyze the company's past cash flows and consider what is expected for the coming months: forecast sales, seasonality, collection and payment terms, planned investments and debt installments falling due.Discounted cash flowDiscounted cash flow is used to estimate the value of a company or a project from the cash flows it is expected to generate in the future, brought to present value. It takes into account the time value of money: one real received a year from now is worth less than one real today, because today's money could be invested (opportunity cost) and because receiving in the future involves risk and inflation. That is why future flows are divided by (1 + discount rate) raised to the number of periods.Companies use this type of cash flow to assess the return on capital invested over the medium and long term, for example when choosing between two investment projects.Cash flow in the accounting standards (IFRS and CPC 03)The IASB (International Accounting Standards Board), based in London, issues the international accounting standards, the IFRS (International Financial Reporting Standards). The international standard on cash flows is IAS 7. In Brazil, convergence with these standards came with Law 11,638/2007, which amended the Corporations Law (Law 6,404/1976) and made the cash flow statement mandatory in place of the old DOAR (Demonstração das Origens e Aplicações de Recursos, a statement of sources and uses of funds). The preparation rules are in Technical Pronouncement CPC 03 (R2) — CPC is the Brazilian Accounting Pronouncements Committee — which is equivalent to IAS 7. A privately held corporation with equity below R$ 2 million at the balance sheet date is exempt from preparing the cash flow statement (art. 176, § 6, of Law 6,404/1976).A change is already scheduled: IFRS 18, brought into Brazil by CPC 51, applies to fiscal years beginning on or after January 1, 2027, and also amends the cash flow standard. Under the new rules, the indirect method starts from operating profit (rather than net income), and most companies lose the freedom to choose how to classify interest and dividends (interest paid and dividends paid become financing; interest and dividends received become investing). What this article describes below is the rule in force in 2026.A project promises to pay R$ 11,000 one year from now. At a discount rate of 10% per year, what is this flow worth today?Answer: R$ 10,000 — in discounted cash flow, the future value is divided by (1 + rate): 11,000 ÷ 1.10 = 10,000. R$ 9,900 is the common mistake of taking 10% off 11,000, which is not the same as discounting.How to prepare the cash flow statementUnder the accounting standards, there are two ways to prepare and present the cash flow statement: the direct method and the indirect method. In both, flows are separated into three groups: operating, investing and financing activities. CPC 03 encourages the direct method but accepts both; companies that use the direct method must also present a reconciliation between net income and cash from operations (CPC 03, item 20A).Direct methodThe direct method, as the name says, consists of classifying all cash (and cash equivalent) inflows and outflows for the period into the operating, investing and financing groups. In this approach, the most complex (and even subjective) part is precisely classifying the flows into the three groups. It may look trivial, but in practice it is not always so.For example, how should dividends paid to shareholders be classified? As operating or financing? And financial expenses (interest paid)? Operating, or financing, since they are the cost of borrowing? Finance Theory offers some clues: it separates investment decisions from the way those investments are financed. Both generate risks and benefits for shareholders but need to be analyzed separately, and the combined effect is enjoyed (or suffered) by the shareholders.By this reasoning, both dividends paid and interest paid would go in the financing group, since they are flows linked to the capital structure. The standard allows this choice. CPC 03 (item 33A), however, encourages interest paid, interest received and dividends received to be classified as operating, and dividends and interest on equity (juros sobre capital próprio, a Brazilian form of shareholder remuneration) paid to be classified as financing.Some prefer to classify interest paid as operating when it arises from the operation's own short-term cash needs (rather than from financing investments), to see an operating cash flow already net of that cost. The same reasoning applies to dividends: cash flow from operations net of dividends can be read as a measure of what is really left over from operating activities.And financial income (interest received)? Operating or investing? The standard accepts both classifications, as long as the choice is disclosed and applied consistently. A tip: check where the investment that generated the interest was classified. If it was treated as an investment, the interest received tends to follow the same group. Just don't confuse things: simply moving money from cash into an investment that qualifies as a cash equivalent (highly liquid, short maturity) is not a cash flow, because the money remains within "cash and cash equivalents".What matters is that management defines classification criteria, applies them consistently over time and makes clear to users of the financial statements which criteria were adopted, so that users can, if they wish, "take apart and reassemble" the cash flow statement as they see fit.The direct method must be analyzed carefully. Without comparison with previous periods, it is hard to tell whether payments and receipts were "good" or "bad": these amounts, on their own, say little. The simplicity of the direct method comes at a cost: the loss of information relevant for analysis, especially in the operating group.Advantages of the direct methodIt allows receipts and payments to be classified by technical rather than tax criteria;It leads the company to be managed with cash in mind;It allows cash information to be available daily.Disadvantages of the direct methodAt first, it adds new work: classifying each receipt and payment;It requires familiarity that the people doing the classification do not always have.Indirect methodThe indirect method is a little more complex: it starts from profit (measured on the accrual basis) and makes adjustments until it reaches cash. These adjustments are not always well understood. Net income (or loss) includes operating and financial components (financial income and expenses) as well as income and expenses that do not affect cash in the period (depreciation, amortization, equity method results, etc.), and all of this needs to be adjusted. In return, you gain information. Adjusted net income gives what can be called operating cash flow generated, the measure of cash generation by the activities. But the activities themselves consume or release cash as payment and collection terms, inventory levels, sales and costs change. So the changes in short-term operating assets and liabilities are added to or subtracted from the operating cash flow generated, until you reach cash flow from operations. This amount must be exactly equal to the cash flow from operations obtained by the direct method, because it is the same cash explained from two points of view. Cash is cash, and it does not change with the method.What changes is the explanation. With the greater complexity of the indirect method, you gain information. For example: if the company significantly increased its average collection period, this shows up in the indirect cash flow as an increase in accounts receivable, which is subtracted from cash. By lengthening the term, the company stopped receiving money (or "lent" more to its customers), and the effect of this change in sales policy is a reduction in operating cash flow. This information does not appear in the direct cash flow. Another example: suppliers lengthened the average payment period. With more time to pay, the company holds more cash, and this shows up in the indirect cash flow as an increase in accounts payable to suppliers, which is added to cash. It is as if suppliers had "lent" more to the company, and that is why cash flow from operations increases.The indirect cash flow is therefore more informative, though more complex. And inventories? Imagine a growing company that opens a new store. Closing inventories will be larger than opening inventories, because the opening ones belonged to one store and the closing ones to two. In the indirect cash flow, this increase in inventories shows up as a reduction in operating cash flow, because part of the cash generated was used to build up inventory.For the published cash flow statement, this is the correct classification: under CPC 03, inventory is an operating asset, and only expenditures that result in long-term assets (such as the new store's fixed assets) go into the investing group. In management analysis, however, it is worth separating this effect: the new store's initial inventory is, economically, part of the investment in the expansion, and not a sign that operations are getting worse.Notice how this "detail" can change the way cash generation is analyzed. Will this inventory increase happen again? Probably not, unless the company expands again. But what if it does not expand and inventories still increase? Then, yes, there is an operating signal to investigate. Why did it happen? Did the cost of goods go up? Is inventory turning more slowly? Is the company selling less? Is there idle inventory?As you can see, preparing and presenting cash flows is not as trivial as it seems: strategic issues are involved, and they are precisely the most relevant ones for analysis.Advantages of the indirect methodIt is cheap to implement: all you need are two balance sheets (opening and closing), the income statement and some additional information from the accounting records;Through the reconciliation, it shows the differences between accounting profit and cash flow.Disadvantages of the indirect methodIt requires reworking the information to convert from the accrual basis to the cash basis and, depending on how often it is prepared, it may take a while to be ready;It depends on the quality of the accounting: if the records are late or contain errors, the calculated cash will be too.Under the indirect method: net income of R$ 10,000, depreciation of R$ 3,000, an increase of R$ 4,000 in accounts receivable and an increase of R$ 2,000 in accounts payable to suppliers. What is cash flow from operations?Answer: R$ 11,000 — 10,000 + 3,000 (depreciation does not leave cash) − 4,000 (sales not yet collected) + 2,000 (purchases not yet paid) = 11,000. Adding the increase in receivables instead of subtracting it leads to R$ 19,000.Under CPC 03 as in force in 2026, how can a trading company classify interest paid on loans in the cash flow statement?Answer: As an operating or a financing activity, applying the choice consistently; CPC 03 encourages operating — item 33A allows both classifications. Mandatory financing classification only arrives with CPC 51 (IFRS 18), for fiscal years beginning in 2027 or later.Example: the same cash flow statement by both methodsThe figure below shows the 2010 cash flow statement of a fictitious company, Cia Exemplo A, by the direct method (left) and the indirect method (right). Under the direct method, cash from operations is 60,000 received from customers − 42,000 paid to suppliers − 6,000 of expenses − 5,000 of income taxes (IR and CSLL, Brazil's corporate income tax and social contribution on net income) = 7,000. Under the indirect method, you start from net income of 4,000 and add back the financial expense (1,000, because interest was classified as financing) and depreciation (2,000, which did not leave cash): 7,000 again. Since receivables, inventories and payables did not change, there are no other adjustments. In both cases, investing of −2,000 and financing of −2,000 (interest of 1,000 and dividends of 1,000) lead to a change in cash of +3,000.The second figure shows the balance sheet and income statement these figures come from. Check: cash and cash equivalents went from 500 to 3,500 (+3,000); net fixed assets stayed at 20,500 because the purchase of 2,000 was offset by depreciation of 2,000; and retained earnings reserves went from 7,600 to 10,600, that is, the profit of 4,000 minus dividends of 1,000.At Cia Exemplo A, if dividends paid had been R$ 2,000 instead of R$ 1,000, with everything else unchanged, what would the change in cash for the year be?Answer: R$ 2,000 — dividends are a financing flow: financing would go from −2,000 to −3,000, and the change would be 7,000 − 2,000 − 3,000 = 2,000. Profit and operating cash flow do not change, because a dividend is not an expense.Exercises1) (AOCP - 2016 - Juiz de Fora City Hall - MG - Administrator) What criterion is used for the economic and financial evaluation of investments that takes into account the time value of money?A) Accounting cash flow.B) Economic cash flow.C) Historical cash flow.D) Discounted cash flow.E) Future cash flow.2) (CESGRANRIO - 2018 - LIQUIGÁS - Junior Professional - Economics) A person bought a property financed under the following payment schedule: 60 equal, consecutive monthly installments of R$ 10,000.00, the first one month after the purchase. Assume the person can invest their money at a positive interest rate.In this situation, it would be financially better for them to pay for the property inA) a single payment of R$ 600,000.00 at the time of purchase.B) 10 equal, consecutive monthly installments of R$ 60,000.00, starting one month after the purchase.C) 20 equal, consecutive monthly installments of R$ 30,000.00, starting one month after the purchase.D) 40 equal, consecutive monthly installments of R$ 15,000.00, starting one month after the purchase.E) 80 equal, consecutive monthly installments of R$ 7,500.00, starting one month after the purchase.3) (FUMARC - 2018 - COPASA - Sanitation Analyst - Administrator) Analyze the statements below on Risk and Rates of Return in Financial Management, marking them T or F according to whether they are true or false:( ) All financial assets are expected to produce cash flows, and the risk of an asset is assessed according to the risk of its cash flows.( ) An asset with a high degree of relevant (market) risk must have a relatively low expected rate of return to attract investors.( ) Stand-alone risk is the risk an investor would be exposed to if he or she held only one asset.( ) The relationship between risk and return is such that no investment will be made unless the expected rate of return is low enough to compensate the investor for the reduced risk of the investment.The CORRECT sequence, from top to bottom, is:A) F – F – T – TB) F – T – F – TC) T – T – F – FD) T – F – T – F4) (INSTITUTO AOCP - 2017 - EBSERH - Administrative Analyst - Administration (HRL - UFS)) There are several company valuation models, all of which embed certain assumptions and varying levels of subjectivity. Because of their greater conceptual rigor and consistency with modern finance theory, priority is given to valuation models based onA) historical cost.B) market value.C) adjusted current cost.D) book value of equity.E) discounted cash flow.5) (FGV - 2015 - CODEMIG - Business Analyst) A company that calculates its Income Tax (IR) and Social Contribution on Net Income (CSLL) under the tax regime known as "Lucro Real" (actual profit) is evaluating an investment project that involves acquiring fixed assets costing R$ 50 million with a useful life of 10 years, after which these assets will have zero book and market residual values. Considering that the depreciation method allowed by the Federal Revenue Service is straight-line and that the "IR + CSLL" rate is 34% per year, the nominal annual cash flow saved by the company due to this government tax incentive is, in millions of reais, equal to:A) 0.1;B) 1.7;C) 3.3;D) 5.0;E) 6.6.6) (FGV - 2015 - CODEMIG - Business Analyst) One model that can be used to project free cash flows to the firm for a given investment project subdivides these flows into three components, giving the following equation: free cash flow to the firm = operating cash flow (−) change in net operating working capital (−) net capital expenditures. Therefore, the negative cash flows that have the greatest negative impact on free cash flow to the firm are:A) loan repayments and short-term investments;B) amortization of intangible assets and long-term investments;C) depreciation of fixed assets and short-term investments;D) depreciation of fixed assets and long-term investments;E) operating cycle payments and long-term investments.7) (CESPE / CEBRASPE - 2022 - ANP - Regulator of New Attributions II - Position 5) A company wants to measure the economic feasibility of a project for a new production plant. Considering this hypothetical situation, judge the following item: "Proper financial planning will allow the company to size its cash flow needs and mitigate the project's liquidity risk."A) TrueB) False8) (FGV - 2023 - DPE-RS - Analyst - Specialized Support Area - Accounting) The Cash Flow Statement (DFC) was introduced as part of the complete set of public sector financial statements in the context of convergence with international standards. A common structural feature of the DFC is the need to show the cash flows associated with three activities: operating, investing and financing.When preparing the DFC in accordance with the Public Sector Accounting Manual (MCASP, Manual de Contabilidade Aplicada ao Setor Público), it is necessary to observe that:A) it is possible to choose between the direct and the indirect method;B) the sum of the three flows must correspond to the difference between the opening and closing cash balances for the year;C) cash flow from financing activities must be aligned with debt limits;D) the result for the year must be reconciled when determining cash flow from operating activities;E) the balances used to prepare it are associated with the asset and liability accounts of the PCASP (the public sector chart of accounts).9) (INSTITUTO AOCP - 2023 - MPE-MS - Analyst - Accounting) According to the Public Sector Accounting Manual (MCASP) – 9th edition, the Cash Flow Statement (DFC)A) may be prepared using either the direct or the indirect method.B) must be prepared using the indirect method.C) must be prepared using the direct method.D) must only be prepared by independent public companies.E) does not need to be prepared or disclosed.Answers1) D — discounted cash flow brings future amounts to present value.2) E — the total paid is the same (R$ 600,000) in every option; with positive interest rates, the later you pay, the lower the present value. The 80 installments defer payment the most.3) D — the second is false (a riskier asset requires a higher expected return) and so is the fourth (the return must be high enough to compensate for the risk taken).4) E5) B — annual depreciation = 50 ÷ 10 = 5 million; tax saving = 5 × 34% = 1.7 million per year.6) E7) A8) B — in the public sector the cash flow statement is prepared by the direct method, and the sum of the three flows equals the change in cash for the year.9) C — the MCASP requires the direct method.
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