These two ways of expressing the money moving in and out of companies are useful for different reasons.
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Cash flow is an accounting term that refers to the rate at which money comes into and goes out of a business. A positive cash flow indicates that more money came in than went out, and a negative cash flow indicates that more money is going out the door than the company is taking in. For example, if a company anticipates $3 million in revenue and $2 million in expenses next year, we can say that the projected cash flow is $1 million.
There are two ways to express cash flow numbers -- nominal and real. Here's what these terms mean, and when they may be useful.
Nominal cash flow
Simply put, nominal cash flow refers to the actual dollar amount of money that a company expects to take in and pay out, without any adjustment for inflation. This is useful for anticipating future revenue and expenses. For example, if a company wants to project how much it will be spending on office rent during the next decade, it could take the dollar amount of its rent, and use the average annual rent increase to project how much it will spend in subsequent years.
Real cash flow
On the other hand, real cash flow is adjusted for inflation in order to reflect the change in the value of money over time. Because inflation can vary significantly from year to year as you can see in this chart, this can help "equalize" cash flow numbers from different historical periods.
Year | Inflation rate (%) | Year | Inflation rate (%) | Year | Inflation rate (%) | Year | Inflation rate (%) |
|---|---|---|---|---|---|---|---|
1987 | 3.6 | 1994 | 2.6 | 2001 | 2.8 | 2008 | 3.8 |
1988 | 4.1 | 1995 | 2.8 | 2002 | 1.6 | 2009 | -0.4 |
1989 | 4.8 | 1996 | 3.0 | 2003 | 2.3 | 2010 | 1.6 |
1990 | 5.4 | 1997 | 2.3 | 2004 | 2.7 | 2011 | 3.2 |
1991 | 4.2 | 1998 | 1.6 | 2005 | 3.4 | 2012 | 2.1 |
1992 | 3.0 | 1999 | 2.2 | 2006 | 3.2 | 2013 | 1.5 |
1993 | 3.0 | 2000 | 3.4 | 2007 | 2.8 | 2014 | 1.6 |
Real cash flow can be useful for analyzing a company's current cash flow in relation to the past. For example, let's say that a certain company had cash flow of $10 million in 2000, and expects $13 million for 2015. Well, since $10 million in 2000 is equivalent to about $13.7 million in 2015 dollars when adjusted for inflation, the company's cash flow actually decreased in terms of the spending power of the money it brought in.
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