Cash flow is the amount of money in and out of your business. Assessing cash flow is an essential step in understanding how operating expenses impact your business’s bottom line.
Many companies use accounting software to do the job. But, depending on the complexity of your business, it may be possible to calculate cash flow using a spreadsheet and some basic math formulas.
Read on to learn more on cash flow, including how to calculate cash flow and how to manage cash flow problems.
Key Points
• Cash flow tracks the movement of money into and out of a business from operations, investments, and financing activities.
• A positive cash flow indicates that a company generates more cash than it spends, supporting growth and financial stability.
• Formulas for calculating cash flow include operating cash flow, free cash flow, cash flow forecasting, and discounted cash flow.
• Cash flow is not the same as profit. Cash flow measures liquidity, while profit indicates financial success.
• Effective cash flow management ensures a business can maintain operations without relying on external financing.
What Is Cash Flow?
Cash flow refers to the movement of money in and out of a business over a specific period. It measures the company’s liquidity and ability to meet financial obligations.
Positive cash flow occurs when more money is coming in than going out, while negative cash flow indicates the opposite. Effective cash flow management ensures businesses can cover expenses like payroll, rent, and loan repayments while investing in growth.
Cash flow is typically divided into three categories: operating, investing, and financing activities, each contributing to a comprehensive view of a company’s financial health.
Why Understanding Cash Flow Is Important
Calculating cash flow lets you see how your business’s expenses (outflows) compare to your company’s income (inflows). A business generally needs to be cash flow positive, meaning monthly revenue exceeds your operating expenses, to maintain a sustained, profitable existence.
Understanding your cash flow cycle also helps you make financial projections, which can inform your decision-making process. It includes:
• Anticipating inventory needs, including how to pay for supplies
• Determining if your prices are reasonable
• Projecting your fixed expenses versus seasonal revenue
Your cash flow projections can help you figure out how you’re going to finance the lean months while being fully prepared for your busy months.
When you’re cash flow positive, you’re likely offering the right services at the right price. But if your revenue isn’t covering your operating expenses, it may be time to rethink your business structure.
No matter what type of business you operate, your cash flow is one of the most critical financial components to understand. Not only does it help you manage your business’s accounts, but it’s also often required by lenders and investors when you apply for financing.
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How Is Cash Flow Calculated?
At its core, cash flow involves subtracting monthly expenses from your monthly balance and income. The money you can transfer to the next month’s balance is your cash flow.
More complex businesses can identify separate categories for cash flow from operations, investing, and financing.
Here, we’ll discuss a few different cash flow formulas: operating cash flow, free cash flow, cash flow forecasting, and discounted cash flow.
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Operating Cash Flow Formula
Your operating cash flow looks at whether your company is making a net profit from its core business operations. It hones in on cash inflows and outflows from a company’s core operations and ignores cash flows related to outside investing or non-core operations.
Any revenue your company has brought in through sales is called your “cash in.”
The expenses, such as rent, payments on small business loans, credit card payments, taxes, salaries, and manufacturing, are called “cash out.”
To calculate your operating cash flow, take the following steps each month:
1. Add the starting balance and revenue to determine your cash in.
2. Add up all expenses to determine cash out.
3. Subtract cash out from cash in.
Your remaining amount is your operating cash flow for the month.
(The formula can include other things for more complex businesses, such as depreciation, but let’s keep things comparatively simple for now.)
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Operating Cash Flow Example
Let’s look at an example for an imaginary company:
XYZ Retail had a balance of $100,000 roll over from June into July. In July, XYZ Retail grossed $400,000 in revenue. Its total cash in is $500,000.
XYZ Retail’s expenses for the month totaled $250,000, and taxes on the profit amounted to $62,500. Its total cash out is $312,500.
As the formula for operating cash flow is:
Cash In – Cash Out = Operating Cash Flow
XYZ Retail’s formula would look like this:
$500,000 – $312,500 = $187,500
Therefore, XYZ Retail has $187,500 of cash flow to roll over. The company will add the $187,500 balance to whatever revenue they make the next month.
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Free Cash Flow Formula
Calculating your free cash flow allows you to determine how much spending money you have after determining operating cash flow and capital expenses.
Capital expenses are funds invested in the long-term life of your business and spent on larger scale purchases like trucks, large machinery, and building purchases. This differs from operating costs because those are day-to-day expenses such as salaries, smaller supplies (e.g., copiers and computers), and building rentals, not purchases.
Once free cash flow has reached an amount with which a business owner is comfortable, the owner typically uses the funds to make decisions about the future, including expansion or hiring additional people or an outside company to provide support.
There are a few ways to calculate free cash flow. However, the simplest takes the following steps:
1. Determine operating cash flow (see the formula in the previous section).
2. Add up capital expenditures.
3. Subtract capital expenditures from operating cash flow.
There are other formulas for calculating free cash flow. But they’re usually for instances where a company hasn’t been closely monitoring its operating cash flow and capital expenditures.
However, if those have gone to the wayside, the formulas you could use in a pinch are:
• (Net Operating Profit – Taxes) – Net Operating Capital Investment = Free Cash Flow
• Sales Revenue – (Operating Costs + Taxes) – Operating Capital Investments = Free Cash Flow
Free Cash Flow Example
Let’s revisit the fictional company XYZ Retail.
At the end of July, XYZ Retail’s total operating cash flow was $187,500.
That same month, they made upgrades to their building to make it more ADA accessible. This would be a capital expenditure because those upgrades are permanent and can help with future success. The total capital expenditure amount was $53,050.
As the formula for free cash flow is:
Operating Cash Flow – Capital Expenditures = Free Cash Flow
XYZ Retail’s formula would be:
$187,500 – $53,050 = $134,450
This means the free cash flow is $134,450.
Cash Flow Forecast Formula
Calculating your cash flow forecast can help you plan month to month, quarter to quarter, or year to year by figuring out approximately how much money you’ll have on hand.
Forecasting cash flow is more complex than operating and free cash flows, as you need more details.
There are two methods of cash flow forecasting: Direct and indirect.
To calculate direct cash flow, take the following steps:
1. Determine cash in.
2. Determine cash out.
3. Subtract cash out from cash in.
4. Do this month over month to make an educated guess for the coming months.
Cash flow can wax and wane depending on the season. Therefore, something like a summer-only direct cash flow amount may not apply to the winter.
While this seems simple on the surface, this isn’t necessarily the case. You need to know precisely where all money is coming and going from. (Luckily, you can set up a spreadsheet to keep track of it, but you should update it frequently to ensure nothing gets missed.)
The indirect method of calculating cash flow forecast focuses on net income and factors affecting profitability — but not cash balance. It uses your profit and loss statements and balance sheet. To use this method, follow these steps:
1. Get your current balance from your balance sheet. If you have previous ones, check those as well.
2. Compare it to your profit and loss statements to get a decent estimate of your monthly cash in and cash out.
This method is more commonly used among people who don’t want to hire a bookkeeper or use accounting software or those with so many transactions that monitoring every single one is difficult.
Neither method is right or wrong; try out both to see which works best for you.
Cash Flow Forecast Example
American Express provides a cash flow forecast template , as well as an example of what it might look like.
Discounted Cash Flow Formula
Discounted cash flow (DCF) estimates the future value of a business based on projected cash flows. It can help determine whether an investment is likely to pay off in the long run.
The term “discounted” is there to account for inflation and the lower value of money received in the future compared to money received now.
The discount rate is usually a company’s weighted average cost of capital (WACC), which represents how much a company must pay to its investors and lenders.
(Note: The discount rate can also be an interest rate; it depends on the type of investment.)
The discounted cash flow formula looks like this:
DCF= ∑ CFt / (1+r)^t
CF = Cash flow
r = discount rate
t = time period
Discounted Cash Flow Example
Let’s put this into an example.
A potential investor in XYZ Retail wants to determine if they’ll see return on investment in three years if they invest $50 million now.
Let’s say XYZ’s cash flow (CF) for Year 1 is $20 million. Based on past performance, we calculate that future cash flow is expected to grow at a rate of 5% each year. So, for Year 2, CF will be $21 million and Year 3, CF will be $22.05 million.
Now, let’s say the WACC for XYZ Retail is calculated to be 4%, meaning 0.04 will be our discount rate (r).
Plugging it into the equation, we find:
DCF = 19,230,769.23 + 19,415,680.47 + 19,601,742.37
DCF = $58,248,192.07
In this case, the investor may see a return on their investment of $50 million in three years. However, it is very important to remember that DCF relies heavily on forecasting, meaning it is not going to be 100% accurate — or a 100% guarantee of a company’s future value.
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Managing Cash Flow Problems
When handling business cash management, many companies experience cash flow hiccups. Frequently tracking and analyzing your finances can help you anticipate challenges and create proactive solutions. Here are five tips on how to better manage cash flow in your business:
Using Accounting Software
While calculating cash flow by hand is great, accounting software can help you keep a closer eye on where money is coming from and going to. Accounting programs can create invoices and track outstanding ones; they can also automatically break down expenses compared to actual cash brought in each month.
Hiring a Bookkeeper
A bookkeeper or accountant can bring to this the human touch that accounting software can’t. For instance, they can analyze the information, then break down the data into layman’s terms.
Small companies may not want or be able to invest in a full-time staff member, but some people do this on a part-time, freelance, or contract basis.
Refining Your Budget
Constantly analyze and refine your cash flow to ensure you have an effective operating budget in place. This can help businesses weather potential or anticipated downturns in business.
Increasing Revenue
Increasing revenue during a period of negative cash flow may require thinking outside of the box.
This might include running an alternative marketing campaign, expanding employee training, and finding creative ways to turn over inventory that isn’t selling well.
Applying for a Line of Credit
Depending on the nature of your cash flow issues and how long you expect them to last, applying for a business line of credit may be an option for getting an injection of capital. This is typically best used if you know what the problem and solution are and need a temporary fix.
Just like with any type of business financing, however, you’ll want to make sure you have a solid plan to repay your balance.
Other Important Financials to Know About
Your business’s cash flow statement is one of many critical financial snapshots reflecting your company’s health. However, there are other ways of monitoring financials, including balance sheets and income statements.
Balance Sheet
Your company’s balance sheet holds valuable information, including assets, liabilities, and details on owners/shareholders.
Assets include cash, inventory, and property. Liabilities include debt, expenses, and owners’/shareholders’ equity. This equity is particularly relevant if they’re paid retained earnings.
A balance sheet reveals important metrics such as your business’s debt-to-equity ratio and amount of working capital.
You typically need to provide your balance sheet any time you apply for business financing or pitch to new investors, along with other documents, so it’s a good idea to have this prepared for any such occasion.
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Income Statement
While your cash flow includes data from the business’s financing and investments, your income statement focuses solely on revenue and expenses over a set period. As a result, it can reveal trends in sales, production costs, and operating expenses.
Depending on the type of accounting used, the income statement may or may not be based on cash accounting.
For example, cash flow measures funds as they enter and leave your business accounts. But using an accrual accounting method, your income statement would reflect when orders are placed rather than paid for.
The Takeaway
Learning how to calculate cash flow is a vital step in understanding your finances. When combined with your balance sheet and income statement, cash flow can be used to keep track of profitable ventures and overspending. It’s wise to regularly review your cash flow to ensure everything is running smoothly.
Cash flow also plays a critical role in getting a small business loan because it shows lenders the company’s ability to repay debt. Strong, consistent cash flow indicates financial stability, reducing the risk for lenders.
If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.
FAQ
What is an example of cash flow?
Cash flow refers to money moving in and out of your business. An example of cash flow is a small business receiving $10,000 in revenue from sales (inflow) while paying $4,000 for rent, $3,000 for salaries, and $2,000 for supplies (outflow) during a given month. The remaining $1,000 represents positive cash flow, which can be used for savings, investments, or loan repayments.
Does cash flow mean profit?
No, cash flow and profit are not the same. Cash flow refers to the money moving in and out of a business, while profit is what remains after all expenses are deducted from revenue. A business can have positive cash flow but still be unprofitable if expenses exceed revenue.
What is a healthy cash flow?
A healthy cash flow means that a business consistently generates more cash inflows than outflows, allowing it to cover operational expenses, repay debts, invest in growth, and maintain financial stability. It indicates strong liquidity and ensures the business can meet both short-term obligations and long-term financial goals without relying heavily on external financing.
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