What is Cash Flow and How to Calculate It


The financial success of small businesses in the United States is directly correlated with their ability to manage cash flow effectively. A staggering 82% of small business failures are attributed to cash flow problems, according to Score.com.

For small business owners, understanding the intricacies of cash flow is imperative for survival and growth. This article aims to help you understand cash flow, its definition, various types, significance, and methodologies to calculate it accurately. By the end, small business owners will know how to steer their businesses toward cash flow success.

What is Cash Flow?

Cash flow is the total amount of money transferred in and out of a business. It’s the same as net cash flow, the sum of cash inflows minus outflows. For instance, if a business earns $100,000 in sales (inflow) and spends $80,000 in expenses (outflow), the net cash flow is $20,000.

Types of Cash Flow in Small Businesses

Cash flow is typically categorized into three main types: operating cash flow, cash flow from investing, and cash flow from financing. Each type provides insights into different aspects of the business’s financial health. Additionally, there’s free cash flow, which offers another perspective on a business’s financial position.

Operating Cash Flow

Operating cash flow is the cash flow generated from a company’s regular business operations. It measures the ability of the business to generate sufficient revenue to cover operational expenses and provide insight into its operational efficiency and profitability.

Cash Flow from Financing

Cash flow from financing includes all the cash transactions related to funding the business. This includes raising capital through issuing stocks or bonds (equity and debt), making dividend payments to shareholders, and acquiring small business loans. These activities reflect how a company finances its operations and growth.

Cash flow From Investing

Cash flow from investing reflects a company’s expenditures and earnings from its investment activities. This includes buying or selling assets like equipment or property and investments in other companies or securities. It provides insights into how a company allocates its capital for long-term growth.

Free Cash Flow

Free cash flow is the cash a company generates after accounting for capital expenditures needed to maintain or expand its asset base. It differs from net cash flow as it subtracts capital expenditures from operating cash flow, indicating the cash available for expansion, dividends, or debt repayment.

Why is Cash Flow Important for Small Business

Cash flow is a great indicator of a small business’s financial health. It’s not just about the amount of money coming in and going out, but understanding where it comes from and where it’s spent. Calculating different types of cash flow, like operating, financing, and investing cash flows, provides a comprehensive overview of a business’s financial activities and health.

Net cash flow, the difference between cash inflows and outflows, is the starting point for determining a business’s short-term viability. Consistently positive net cash flow suggests a business is doing well, able to meet its debt obligations and invest in growth. It reflects a business’s ability to generate enough revenue to sustain its operations and expand. Conversely, a negative net cash flow raises red flags about potential financial or operational issues, signaling that expenses outweigh earnings, which can lead to liquidity problems.

Operating cash flow is another way to show the efficiency of a company’s core business activities. It shows whether a business earns enough from its core operations to sustain itself. Cash flow from financing activities illustrates how a business raises capital and manages its debt structure, while cash flow from investing activities provides insights into how effectively a company is investing in its future growth. These cash flow types paint a detailed picture of a small business’s financial situation and future potential.

Understanding Cash Flow Statement

A cash flow statement is a financial document that provides a detailed cash flow analysis of what happened to a business’s cash during a specific period. This statement is divided into three main components: cash flow from operating activities, investing activities, and financing activities. Each section offers insights into different aspects of the business’s cash movements.

To read and analyze a cash flow statement, begin by examining the cash flow from operating activities. This section reveals the cash generated or used in the business’s core operations. For instance, if a company shows a positive cash flow from operations, it indicates that it is earning more revenue than it spends on day-to-day expenses.

Next, review the cash flow from investing activities, which includes purchases or sales of assets, loans made to vendors, or any payments related to mergers and acquisitions. A negative number here usually means the company is investing in future growth.

Lastly, assess the cash flow from financing activities. This section reflects transactions such as issuing stock, paying dividends, or borrowing funds. For example, a positive number might indicate new loans or investments, whereas a negative number could mean the business is paying off debt.

These sections provide a holistic view of a business’s liquidity and financial health.

How to Calculate Operating Cash Flow

The formula for calculating Operating Cash Flow (OCF) starts with net income and then adjusts for non-cash expenses and changes in working capital.

The formula can be expressed as:

OCF = Net Income + Non-Cash Expenses – Changes in Working Capital.

You’ll need to refer to the business’s balance sheet and income statement to find these numbers. Net income provides the starting point, non-cash expenses (like depreciation) are added back, and any increase or decrease in working capital is accounted for. For instance, if a company’s net income is $50,000, non-cash expenses total $5,000, and working capital increases by $3,000, the OCF would be $50,000 + $5,000 – $3,000 = $52,000.

How to Calculate Cash Flow from Financing

Cash Flow from Financing (CFF) is calculated by summing the debt, equity, and dividends transactions. The formula includes adding the cash received from issuing stock or debt and subtracting cash used to repurchase stock, repay debt, and pay dividends.

CCF = Cash from Stock Issuance or Debt Procurement – Cash for Stock Repurchase or Debt Repayment

For example, if a business issues new shares worth $20,000, repays debts of $10,000, and pays out dividends worth $4,000, the CFF would be $20,000 – $10,000 – $4,000 = $6,000. A positive CFF indicates that the company has brought in more money from financing activities than it has spent.

How to Calculate Cash Flow from Investing

Cash Flow from Investing (CFI) measures the cash used or generated from a company’s investment activities. To calculate CFI, determine the net cash flow from transactions such as capital expenditures (CapEx), mergers and acquisitions, and buying or selling marketable securities.

The formula is: CFI = Earnings from Investments – Capital Expenditures – Depreciation.

For example, if a company earns $40,000 from investments, spends $30,000 on new equipment (CapEx), and has a depreciation of $5,000 for the year, the CFI would be $40,000 – $30,000 – $5,000 = $5,000. This result indicates the net cash flow generated from the company’s investment activities.

How to Calculate Free Cash Flow

Free Cash Flow (FCF) represents the cash a company can generate after accounting for the cash outflows to support operations and maintain its capital assets.

To calculate FCF, subtract capital expenditures from the operating cash flow.

The formula is: FCF = Operating Cash Flow – Capital Expenditures.

For instance, if a company’s operating cash flow is $50,000 and it spends $10,000 on capital expenditures, the FCF would be $50,000 – $10,000 = $40,000. This figure is a crucial indicator of a company’s profitability, liquidity, and overall financial health.

Frequently Asked Questions about Cash Flow

What is the difference between cash flow and profit?

Cash flow and profit are distinct aspects of a business’s financials. Profit, or net income, is the amount of money a company earns after all expenses are subtracted from its total revenue. It measures overall earnings. On the other hand, cash flow refers to the actual movement of cash into and out of a business. It directly indicates a company’s ability to sustain operations, pay debts, and invest. For small businesses, managing cash flow is often more critical than profit, as it directly affects their ability to remain operational and solvent, especially in the short term.

What is the difference between cash flow and revenue?

Revenue and cash flow serve different purposes in financial analysis. Even though they are related, they are quite different. Revenue is the total income generated from selling goods or services, regardless of when the money is actually received. In contrast, cash flow accounts for the real-time inflows and outflows of cash within a specific period. The revenue formula typically sums up all income from sales and services, while net cash flow calculation involves subtracting cash outflows (expenses) from cash inflows (revenue and other sources). This means a business can be profitable (high revenue) yet still face cash flow issues if the income is not received in time to cover immediate expenses.

What is cash flow forecasting?

Cash flow forecasting is the process of estimating the future flow of cash in and out of a business. It involves predicting cash inflows, such as expected sales revenues, and outflows, like rent, payroll, and other expenses, over a specific period. This forecast helps businesses anticipate and plan for future financial situations, ensuring they have enough cash to cover upcoming obligations and make informed decisions about investments, savings, and growth strategies.

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