Nominal vs. Real Cash Flow

Nominal vs. Real Cash Flow
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In financial accounting, cash flow refers to the rates at which money flows into, and out of, a business or organization. Cash flow is important because it shows how well a business is able to meet its financial obligations in the near term. Businesses with high net worths but poor cash flow can run into serious financial problems simply because they lack access to the cash they need when they need it. Nominal cash flow and real cash flow are two ways of calculating cash flow.


Nominal cash flow and real cash flow each refer to the same sources and destinations for cash within a business. However, they use different computations to determine the value of this cash. Real cash flow uses a very basic measurement, counting all cash flow for the future at its present value. Nominal cash flow accounts for inflation, which affects the price of goods by altering the value of currency. This makes nominal cash flow figures generally larger. It also makes nominal cash flow a more precise measurement, but with more opportunities for forecasting error.


One example of the difference between real and nominal cash flow is the cost of electricity, which represents a liability, or a source of outflow of cash, for a factory. To project nominal cash flow, the factory's accountants will examine trends in inflation throughout the economy to estimate the unit price of electricity five years in the future. Using real cash flow, the factory's accountants would simply use the current price of electricity. A nominal cash flow forecast would also apply inflation to the price of the goods that the factory produces, the cost of its raw materials, its labor costs and the interest it earns on its investments.


Real and nominal cash flow figures can radically alter a business's projected cash flow and approach to handling its assets. Real cash flow is useful for determining the balance of cash flow into and out of the business, but only nominal cash flow helps analysts examine specific items that make up the cash flow. Nominal cash flow is often based on real cash flow, so businesses may be able to provide both figures for analysis. Nominal cash flow does not appear on a business's cash flow statement, which is one of the key financial statements businesses release, because it can only refer to future cash flow estimates.


Even with access to both nominal and real cash flow methods, accountants and analysts still face complications in forecasting future cash flow. It is possible that neither option will produce an actual cash flow figure that matches what a business receives, or pays, for specific items in the future. Changes in the business's purchasing and borrowing needs, along with its revenue, also affect cash flow, whether nominal or real. In practice, most accounting mixes real and nominal cash flow estimations for the most useful results based on what an analyst is trying to learn.