Retained cash flow helps companies to invest in their future opportunities without the requirements of external financing options.
Retained cash flow
The amount of cash the company generates from its operations that is not distributed to its shareholders or used to pay company debt, but kept in for the future of a company is known as retained cash flow.
It is an essential financial metric of a company. Because it shows the amount of cash that can be reinvested in future growth opportunities of a company. Such as research and development ( R&D ),capital expenditures, marketing, and acquisitions.
How to Calculate Retained Cash Flow (RCP)
By subtracting the capital expenditures and dividends paid from the operating cash flow, we get the retained cash flow of a company.
The formula to Calculate Retained Cash Flow is:
Retained Cash Flow = Operating Cash Flow - Capital Expenditures - Dividends Paid
Operating cash flow: The amount of cash that a company generates from its day-to-day activities is known as operating cash flow. Such as sales and marketing, salaries paid to employees, etc.
Capital expenditure: The process in which invest for a company's long-term purposes is known as Capital expenditure. such as the purchase of land, computers, equipment, software, building, etc.
Dividends: The process in which a company pays a reward to its shareholders in the form of cash or stock is known as Dividends.
The positive retained cash flow indicates that a company has sufficient funds to cover its operations and to invest in future opportunities without any kind of financing.
Example of Retained cash flow
Suppose a company XYZ generates $100000 from its operating activities in a year. In the same year, the company spend $20000 cash on capital expenditure and pay $5000 in dividends to its shareholders.
So, by using the formula of Retained Cash Flow we can get the amount of cash that a company XYZ generates.
Retained Cash Flow = $100,000 ( operating activity ) - $20,000 ( Capital expenditure ) - $5,000 (divided paid )
It means that company XYZ has $75,000 cash which it can use to invest in a company's future opportunities.
Importance of Retained Cash Flow:
There are several reasons why Retained Cash Flow is important. Some of them are:
1. Additional financing
Firstly, retained cash flow is important because it shows that the company is generating enough funds to cover its operations and long-term growth without the requirement of Additional financing. Such as debt, crowdfunding, etc
2. Share dilution
Another benefit of retained cash flow is that it helps companies to invest in their growth without Diluting shareholder value.
This is also important to retain and gain investors because it shows that the company can grow and its share value may increase in the future.
3. Financial Health
The positive retained cash is an indicator of the better financial health of a company. It shows that the company does not have to suffer from cash flow losses and will grow in the future.
Read also:
How to deal with cash flow problems in small business
What are the Uses of Retained Cash Flow
There are many ways to use Retained Cash Flow such as:
1. Research and development ( R&D ):
Companies can use retained Cash Flow for R&D purposes. For instance: if a company wants to create a new product in the market then the company can use retained Cash Flow for the R&D of that product.
2. Capital expenditures
Retained cash flow allows companies to invest in Capital expenditures for long-term business growth without a bank loan or any other financial burden.
3. Sales and marketing
Sales and marketing are essential to increase brand awareness and to sell a product and with retained cash flow company gets the benefit to invest in Sales and marketing.
Read also:
8 ways on How small businesses can reduce costs and increase revenue or profit in 2023
What is the difference between retained cash flow and free cash flow?
Retained Cash Flow and Free Cash Flow both are important financial metrics of a business. But, both of these are not the same.
The difference between Retained Cash Flow and Free Cash Flow is:
Retained Cash Flow: It is the amount of cash which is generated through the business's operating activity and it is used to invest in the business's future, rather than paying debt or distributing it to shareholders.
On the other hand, Free cash flow is the amount of cash left in a company before paying cash from operations and capital expenditure.
Free cash flow = cash from operations - capital expenditure
What is retained cash flow to debt ratio?
retained cash flow to debt ratio is an important financial metric of a business that measures the relationship between a business retained cash flow and its outstanding debt. It helps to determine the ability of a business to pay its debt, through internally generated cash flow.
To calculate retained cash flow to debt ratio, we divide the retained cash flow by the total outstanding debt.
Formula:
Retained Cash Flow to Debt Ratio: Retained Cash Flow / Total Outstanding Debt
A higher ratio indicates that a company generates enough cash from its operations to pay its debt without any external financing.
On the other hand, the lower ratio indicates that a company does not generate enough cash from its operations to pay its debt and it may require an external financing option.
Retained Earnings
The portion of profit which is kept in a business, without paying it to company shareholders in the form of dividends is known as retained earnings. It is reported on a company balance sheet.
Retained Earnings are a beneficial source of funding for a company because in this the company does not have to dilute the value of shareholders.
To calculate retained earnings, we have to subtract the dividends paid to shareholders from the company's net income.
Formula:
Retained Earnings = Dividends Paid to Shareholders - The Company's Net Income
Example of retained earnings
Suppose a company ABC generates a net income of $ 2 million and pays $50,000 to its shareholders. So according to the formula, the retained earnings of a company are $ 1,950,000.
retained earnings in the cash flow statement
Retained earnings are not reported in the cash flow statement of the company but they put an impact on it. Because the cash flow statement shows the cash inflows and outflows of the company during a specific period and by examining the total cash flows from operating and financing activity we can guess the impact on Retained earnings.
For instance:
If a company generates positive cash flow from its operating activities and uses that amount of cash to invest in its future growth opportunities or to pay its debt then the retained earning of the company will increase over time.
On the other side, If a company generates negative cash flow from its operating activities and uses bank loans or other financing options for growth purposes then the retained earnings of the company will be less over time.
Related searches:
How can retained cash flow impact a company's ability to pay dividends to shareholders?
If the company has a positive retained cash flow then it does not require any external funding option to pay dividends to shareholders or to invest in the business's future. The company can use the cash from retained cash flow to pay shareholders in the form of dividends or to invest in the business's future.
What are some examples of companies with high retained cash flow?
There are various companies with high retained cash flow. Some of them are:
1. Alphabet
This is a parent company of Google which has a high retained cash flow. In 2020, Alphabet's retained cash flow was $22.5 billion
2. Apple
Due to Apple's strong cash flow from operations, it also has a high retained cash flow. In 2020, Apple's retained cash flow was $73.4 billion.
3. Facebook
Facebook has a low capital expenditure and a positive cash flow from operations. In 2020, Facebook's retained cash flow was $19.3 billion.
You may like:
what happens when cash flow is reinvested in the business
small business cash flow management: Everything you should know
Cash flow investment loan: Definition and Example
