What is Cash Flow? How to Calculate It and an Example (2024)

Anyone with a personal checking account knows the challenge of knowing how much money is available to pay bills. The goal of monitoring your checkbook is to make sure that the money coming in exceeds the money going out. The movement of money in and out of your checking account represents your cash flow.

Businesses are like families in that respect. They watch their checkbooks closely and Positive cash flowor raise (or raise) funds from other sources to forecast the likelihood of a negative cash balance. Next, we’ll take a closer look at the different types of cash flows.

What is cash flow?

Cash flow is a record of both money received (cash inflow) and money paid (cash outflow) during a particular period of time. Cash Flow Management We ensure that there is more inflow than outflow.

accounts receivableor money owed to a business; and accounts payableMoney that a company owes is ignored in cash flows; it is recorded in a different way. Financial Statements, Balance sheetare one of a company’s total assets and liabilities. A company can only use them when its accounts receivable are collected and its accounts payable are paid. Net cash flow.

Cash Flow and Profit

Due to different accounting methods, a company’s profits and cash flows can vary significantly. Profit and loss statement (also called income statement) Use Accrual accountingThis means it records revenues, expenses, and profits incurred during a particular period, regardless of when the money was received or paid.

For example, if a company sells $10 million worth of goods in a particular period, it will record the full amount on its income statement, even if it has not yet collected the full $10 million from its customers.

Similarly, if the expense is $8 million, it will be recorded in full because it was incurred during the period, even though payment of a portion of the expense has been deferred. Cash AccountingIn contrast, it records only the portion of revenue collected during the period and the portion of expenses actually paid.

The Importance of Cash Flow

Cash flow is important to businesses because it is a key factor in basically keeping a business running. Businesses need to either maintain a positive cash flow or anticipate a negative cash flow by raising (or raising) funds from other sources.

Maintaining a positive cash flow allows you to pay bills like payroll, rent, suppliers, etc. Without sufficient cash flow, you will struggle to meet your financial obligations and risk potential bankruptcy.

Adequate cash flow also allows a company to invest in new opportunities, such as expanding into new markets, developing new products, or acquiring other companies. It also gives a company the financial flexibility it needs to pursue a growth strategy.

Healthy cash flow is a key factor in economic downturns and Supply chain disruptionsIt also makes the company more attractive to investors and lenders if it needs outside financing.

Types of Cash Flow

There are three main types of cash flows widely recognized in business accounting, with additional types employed in some industries and regions. U.S. companies typically report them on the cash flow statement in their quarterly financial reports. Cash flows are:

Operating Cash Flow

Operating Cash Flow It tracks the flow of money resulting from the production and sale of a company’s goods and services. It includes cash received from a company’s business activities minus cash expenditures (which include cost of goods sold and stored) and general and administrative expenses.

Operating cash flow is the most important because it indicates whether a business is viable and regularly earns enough money to pay its bills without needing outside funding. Funding.

Investment cash flow

This tracks money spent or received in buying or selling a business assetsThis includes assets such as real estate and equipment. It also includes money spent to buy stocks, bonds, and other securities, as well as dividends and interest received from those investments.

Although invested cash may indicate a negative balance, it’s not necessarily a red flag if the cash is invested in income-producing assets such as inventory or in activities such as: Research and Development It can bring in future sales and profits.

Cash flow from financing

Cash flows from financing include funds a company receives from outside sources to operate its business. loan or the sale of bonds, the sale of stock to investors, or a public offering of stock. It also accounts for money used to repay the principal of loans or bonds (interest paid on loans and bonds is paid from cash from operations), buy back stock or shares, and pay dividends.

Cash from financing indicates how much a company relies on external sources of funding, as opposed to cash generated internally by business operations.

Unlevered Free Cash Flow

Unlevered Free Cash Flow It is the money that a company has left after investing in its assets and before paying interest on its liabilities.

It doesn’t take into account the cost of debt that may be used to operate the business. Debt usually takes the form of bonds or bank loans. So unlevered free cash flow is the amount of cash a business has available to use before deducting interest expenses on debt. Analysts and investment managers often use this figure.

Discounted Cash Flow

Discounted Cash Flow It’s a way of estimating the value of something based on how much money it is expected to generate in the future.

The primary purpose of discounted cash flows is to determine the theoretical value or price of an asset, such as a company’s fair value. Comparing the discounted cash flows a company generates to its stock price can help investors determine whether a company is undervalued or overvalued.

Increased Cash Flow

Increased Cash Flow It helps companies measure the profitability of individual projects and investments and decide which to pursue. Determining incremental cash flows allows a company to compare expected cash flows between projects. This helps a company identify which projects are profitable and where to invest funds.

How to Calculate Cash Flow

Cash flow can be calculated in a number of ways, depending on the type of cash flow you are looking at. Three commonly cited types are listed below: Cash Flow Formula Calculate each one.

You don’t have to be a mathematician to do this, there are online tools and calculators available to help you. Shopify Cash Flow CalculatorJust enter the numbers and see the results.

Operating Cash Flow

The formula will vary depending on how much detail a company provides. Many large companies provide a line item that describes their operating cash flow. But if you don’t have a cash flow statement, you can calculate it using this basic formula:

Net Income + Non-Cash Expenses – Change in Working Capital – Taxes = Operating Cash Flow

Non-cash expenses on the income statement are added to cash flows. These expenses include depreciation of asset values ​​and stock-based compensation to employees. Net change in working capital working capital, which is current assets minus current liabilities. tax This will be deducted because you must pay in cash.

Free Cash Flow

Free Cash Flow Free cash flow is the amount of cash needed to operate a business, minus expenditures to maintain or upgrade business assets like factory, offices, etc. Such expenditures are called capital expenditures or Capex, and the formula for calculating free cash flow is:

Operating Cash Flow – CAPEX = Free Cash Flow

Free cash flow is calculated by financial analysts and company managers and is an important indicator of a business’s strength because it shows how much money is available to expand, make acquisitions, pay dividends, buy back stock, and repay debt. Free cash flow measures how much a company can rely on its own resources without needing to raise outside capital.

Cash flow forecasting

The company prepares a budget Seasonal forecast To grow sales and improve profitability, Cash flow forecastingThe simple formula is:

Beginning cash balance + projected inflows – projected outflows = cash flow forecast

prediction It may be necessary to incorporate expected price and cost changes over the forecast period – for example, a company may expect a 10% increase in product costs and overhead costs and plan to increase prices by 12%. Cash flow forecasts may need to be continually monitored and adjusted based on the actual flow of funds into and out of the company.

Cash Flow Example

Below are hypothetical examples of cash flows based on accrual and cash basis accounting.

An entrepreneur who makes sports apparel has grown his business to about $10 million in monthly sales, generating $2 million in profits on $8 million in expenses.

However, half of the sales, or $5 million, are due in 30 days from customers, leaving the remaining $5 million as cash sales.

Meanwhile, the entrepreneur would pay $4 million of his monthly expenses in cash, with the remaining $4 million being paid on 30-day credit terms.

So the business had profits of $2 million, but cash flow was half that amount.

Cash sales $5 million – cash expenses $4 million = $1 million

Accrual accounting follows a principle known as the matching principle, which means that revenues in a particular period are matched with the expenses associated with realizing those revenues. So in the above example, the $10 million in revenues and the $8 million in expenses would be matched in the same period, rather than just the cash portion of each being matched in cash accounting.

Cash flow is important for any business

When you started your business, you probably didn’t imagine yourself messing around with spreadsheets, but some of these less-than-sexy processes are actually crucial to your success. If you don’t know your future cash flow, you might not have enough money to continue operating. Luckily, there are calculators, templates, and formulas to help you understand your business’ cash flow and improve your profitability.