Retained Cash Flow: What is RCF?
Cash flow will always be one of the most important metrics to review when you run a business. Understanding all elements of cash flow management – including retained cash flow – can be quite a tricky task. However, we are here to help you understand more about RCF and how you can use it.
What is retained cash flow (RCF)?
Retained cash flow (RCF) is the amount of cash generated by a business that is not paid out to shareholders as dividends, but is instead retained by the company to be reinvested in the business or held as a reserve for future use.
How does retained cash flow work?
There are a few steps involved in understanding how retained cash flow works.
1. Cash generation
A business generates cash through various operations. This cash is used to pay for expenses, taxes, and any dividends owed to shareholders.
2. Calculation of RCF
To calculate RCF, the total cash generated by the business is reduced by the capital expenditures (CAPEX) and dividends paid out during the period. We explore CAPEX below.
3. Reinvestment or reserve
The remaining cash after subtracting CAPEX and dividends is the RCF. This cash can be reinvested back into the business for future growth or held as a reserve to meet unexpected expenses or problems.
4. Explore the benefits of RCF
Retaining cash flow can provide several benefits to businesses, such as funding new projects, improving financial flexibility, and increasing shareholder value.
5. Impact on financial statements
RCF is recorded on the balance sheet as a component of shareholder equity. It is also reflected in the cash flow statement as the change in cash and cash equivalents during the period.
RCF is such an important aspect of cash flow management. It allows businesses to maintain financial stability and make strategic decisions for long-term growth.
How to calculate retained cash flow
To calculate retained cash flow (RCF), you need to follow a simple formula that takes into account the cash generated by the business, capital expenditures (CAPEX), and dividends paid out to shareholders.
RCF formula
RCF = cash flow from operations – CAPEX – dividends
Cash flow from operations refers to the net cash generated by the business from its core operations, such as sales, services, or investments, after subtracting all operating expenses. This figure can be found on the cash flow statement.
CAPEX refers to the amount of cash spent on investments in fixed assets, such as buildings, machinery, or equipment. This figure can be found on the balance sheet or the cash flow statement.
Dividends refer to the cash paid out to shareholders as a reward for their investment in the business. This figure can be found on the statement of changes in equity.
Once you have these figures, you can plug them into the formula to calculate RCF.
An example of retained cash flow
Let’s say a business generated $1 million in cash flow from operations during the previous fiscal year. This business also spent $500,000 on capital expenditures to purchase new machinery and equipment and paid $100,000 in dividends to its shareholders.
To calculate this business’ retained cash flow (RCF), we can use the formula:
RCF = cash flow from operations – capital expenditures – dividends paid
RCF = $1,000,000 – $500,000 – $100,000
RCF = $400,000
Therefore, the retained cash flow for the previous fiscal year is $400,000. This means the company has $400,000 available to reinvest back into the business for future growth initiatives or hold as a reserve for unexpected expenses or downturns.
This can then be used to fund various growth initiatives, such as expanding its product line, opening new locations, or investing in marketing and advertising to increase sales. Alternatively, the company can hold the cash as a reserve to help weather any unexpected challenges or downturns in the future.
By retaining cash flow, businesses can maintain financial stability, increase its competitiveness, and make strategic decisions for long-term growth.
What is the importance of retained cash flow?
Retained cash flow (RCF) is important for businesses in several ways:
Funding growth initiatives
RCF provides a source of internal funding for businesses to invest in growth initiatives, such as expanding the business, developing new products or services, or entering new markets. This can help businesses to increase their competitiveness, market share, and profitability over the long term.
Financial flexibility
Retaining cash flow can provide businesses with financial flexibility to respond to unexpected expenses or economic downturns. Having a reserve of cash can help businesses to weather difficult times without having to resort to external funding sources, such as debt or equity, which can come with higher costs and risks.
Control over operations
Retaining cash flow can allow businesses to maintain control over their operations and make strategic decisions for long-term growth without having to rely on external investors or lenders. This can help businesses to avoid diluting their ownership or giving up control of their business to outside parties.
Increasing shareholder value
By retaining cash flow, businesses can reinvest in their operations and increase their profitability, which can in turn increase shareholder value. This can be achieved through various means, such as share buybacks, dividend payments, or reinvestment in growth initiatives.
Avoiding high-interest debt
Retaining cash flow can help businesses avoid high-interest debt, which can be costly and increase financial risk. By having a strong cash position, businesses can negotiate better terms with lenders or avoid borrowing altogether.
Retained cash flow vs. free cash flow
Retained cash flow (RCF) and free cash flow (FCF) are both important financial metrics for businesses, but they measure different aspects of a company’s cash flow.
As we have discussed, retained cash flow measures the amount of cash generated from a business’s operations that is retained after capital expenditures and dividend payments.
On the other hand, free cash flow measures the amount of cash generated by a business’s operations that is available to be used for various purposes, including reinvestment in the business, paying dividends, paying down debt, or returning cash to shareholders through share buybacks.
The formula for free cash flow is:
FCF = Cash flow from operations – Capital expenditures
FCF represents the cash that is available to a business after deducting the capital expenditures required to maintain its existing operations.
In essence, RCF is a subset of FCF because it focuses on the cash that is retained after the company has made its required capital expenditures and paid dividends. FCF, on the other hand, represents the total cash generated by the business that is available for various uses.
Can a Financial Modelling Tool be used to help RCF?
A financial modelling tool can be a valuable asset to help with retained cash flow (RCF) analysis and planning. Using a tool like Brixx, businesses can perform “what-if” analysis to understand the impact of different scenarios on their RCF. For example, businesses can model the impact of changing their capital expenditure levels, dividend policies, or sales growth rates on their RCF.
A financial model can also help businesses identify key drivers of their cash flow and monitor them over time. For instance, by analyzing historical data, businesses can identify trends in their revenue and expenses, which can help them forecast their future cash flow and RCF.
Moreover, a financial modelling tool can help businesses develop a long-term financial plan that aligns with their strategic objectives. By modelling various scenarios, businesses can develop a roadmap for future growth initiatives, such as expanding their operations or developing new products or services, and estimate the impact of these initiatives on their RCF.
Overall, a financial modelling tool can be a powerful tool to help businesses manage their cash flow, plan for the future, and optimize their RCF. By using a financial model, businesses can make informed decisions about their finances, allocate resources efficiently, and achieve their long-term objectives.
