Retained Cash Flow

Retained Cash Flow refers to the cash balance left over or retained within the business after paying off all obligations at the end of a financial period. It is a measure of the net increase or decrease in the cash or its equivalent for that period.

Since retained cash flow is the amount remaining with the company after all obligations are cleared off, it reflects the financial condition and funds available for further investment in productive purposes. It can be used to create the budget for the next financial year and plan for upcoming expenses. It is the cheapest source of funds for any business.

• It is the cash amount that is left in the business after meeting all its obligations.
• It is a good measure of the financial strength of the company and is useful if the company plans to go for further borrowing or raise funds through some other source.
• This fund can be invested for more productive and useful purposes that may generate good returns.
• Companies often use such funds while making provisions or creating budgets for the next financial year. There is no need for the business to incur extra expenses to access this cash.

Retained cash flow refers to the cash left over within the business after meeting all financial obligations throughout the year. The obligations may include dividend or debt payments, meeting operational expenses, etc. It is a useful metric for gauging the financial health of the business and assessing its overall performance throughout the year.

This extra cash is often used for meeting any unforeseen obligations, making a budget for the upcoming years, and planning for any expense or investment that may give lucrative returns.  Management and analysts may select projects and investment opportunities that offer a positive amount for Net Present Value (NPV) and use this cash balance to help the business move forward and expand.

It is a preferable method for the business to accumulate funds because there is no need to incur any extra charges for raising money like that of borrowing from lenders or raising public funding from the issue of shares. This money already exists within the company, and the management has access to it at any time.

Calculating it using the retained cash flow formula is not a very complex process because we can simply deduct the cash outflow from the cash inflow amount. However, to get an in-depth report regarding the same, it is necessary to analyze the cash flow statements for the two financial years before that. However, it is to be noted that companies generally take the difference in the operating cash flows of two financial years after deducting the dividend amount paid from each.

The retained cash flow calculation of the same is done in the below-mentioned manner.

Typically, since it is a calculation of cash balance, it will involve deducting cash outflow from cash inflow. For this purpose, we need to select the cash flow statements of two consecutive years before the year in which the retained value of cash flow is required.

From the cash flow statement of those two years, one finds the values of operating cash flow, which deducts the operating expenses from the revenue earned by the company for both years. For each year, they need to take away the dividend paid out from the operating cash flow to get actual cash flow. Then, we find the difference between these two cash flow balances to find the retained cash flow, which is the retained cash flow formula.

Let us understand the concept of retained cash flow calculation with the help of some suitable examples as given below:

Example #1

We assume that ABC Ltd is a company that is listed on the stock exchange and is planning to raise funds for internal purposes. However, it does not want to incur much expense by issuing shares or taking loans from investors. The management decides to go through the financial statements to analyze how much cash they can afford to utilize from within the business. As per their finding, for the year 20xx, the operation cash balance is $400 million, out of which the dividend is paid for $60 million. In the next year, which is 20yy, the operating cash balance is $300 million, out of which the dividend is paid for $70 million. Therefore, the current cash flow retained within the business will be $110 .

Example #2

Let us take another example of a company, XY Ltd, which is a small start-up and has to get funds for office renovation and expansion. It cannot raise money from stock market since it is not listed, and it already has debt in the form of loans from banks. Therefore, it decides to check for any cash balance within the business. XY Ltd finds a substantial amount of cash and cash equivalent within the business itself and uses it for buying new office space, furniture, and other arrangements. Thus, we see that the cash balance proves to be a good source of funds for immediate need, free or cost.

There are several ways to improve or increase the retained cash flow within the company. Let us study the same in detail.

• Lease - Since buying takes a lot of investment, it is always better to lease. Leasing office space, furniture, machinery, buildings, etc., will require less cash outflow at a time because buying will require paying a substantial amount.
• Early payment discount – If customers are paying earlier than the credit period, it is always a good practice to allow them some discount to lure them to continue paying before the date. This will lead to cash inflow to the business before the estimated time.
• Customer’s creditworthiness – The assessment of customers' creditworthiness is very important. If they are not in a position to pay for the purchases and still buy goods on credit, it may lead to bad debt, resulting in losses for the business and a fall in cash flow figures.
• Peer cooperation – In markets where the competition is huge and the price of goods matters a lot while retaining customers, forming cooperatives with peer companies is a good idea because it helps in gaining competitive pricing. This is also a way to pool funds for bulk buying from suppliers at discounts.
• Better marketing – New and improved methods of marketing are equally important to increase cash flow that can be retained within the business. Good marketing will boost sales and revenue, leading to higher profits and better financial conditions. This also means more customer base and higher cash flow, provided the collection and payables are managed efficiently.
• Increase inventory turnover – Inventory turnover, which means the number of times the inventory is purchased and more out of the warehouse, should increase. It means inventory is not lying idle, and cash is not blocked. Rather, it is available for better productive purposes.
• Cost control – A crucial part of any company operation is control of cost.  If cost increases, it leads to the depletion of cash through payment of unnecessary expenses, which eat away the revenue, reducing profits.

All the above methods suggest how to increase cash inflow as well as minimize the cash outflow within the business. This will lead to the accumulation of a positive cash balance for the company that can be retained after meeting all necessary obligations.

Some points that highlight the importance of the concept of retained cash flow calculation are as follows:

• Business efficiency – It highlights how financially efficient and strong the business is and its ability to withstand a sudden economic crisis. A negative cash flow will indicate that the business has a shortfall of cash, which may lead to a crisis later.
• Ability to get funding - A financially strong company will easily get extra funding from investors, who will typically assess the creditworthiness of these companies and then extend loans.
• Facilitate expansion – A good cash balance and cash flow will ensure there is enough finance to invest in new projects and opportunities for growth and expansion.
• Heavy purchases – Such cash can be ideally used to make any heavy purchase like machinery, furniture, real estate, or hiring resources for business.
• Cheap credit source – This is a good source of credit for the company when needed to meet various expenses for the short or long term. There is no need to incur extra charges like payment of interest or fees to raise money.
• Accumulation for other uses – This money can often be accumulated to meet any sudden needs or make provisions for unforeseen contingencies if they are not immediately required. So, companies may keep accumulating retained cash within the business.

The above points highlight the importance of such cash balances. However, it should be noted that the importance and need may vary as per the needs of the company and its financial condition.

Both the above refer to funds that are held back into the business, but the difference lies in how they are accumulated and used. Let us study the differences as given below:

• The former refers to a positive cash balance that the company will keep within the business, and the latter refers to part of the profits that the company will keep within the business.
• A positive value of the former denotes that the cash position of the business is powerful due to efficiency in credit sale and collection, controlled cost, and less resource wastage, and it can meet financial obligations. A positive value of the latter denotes that the business can make huge sales and revenue, which leaves a substantial balance as profits, even after meeting all expenses.
• The former is calculated after the payment of dividends, but the latter is that part of the revenue that is set aside and not paid out as dividends.

This article has been a guide to what is Retained Cash Flow. We explain how to calculate it, its examples, its importance, & comparison with retained earnings. You may also find some useful articles here -

• Cash Flow Statement Indirect Method
• Positive Cash Flow
• Cash Flow From Assets