Cash flow is the movement of actual dollars into and out of a business and does not include non-cash items. One example is that accounts receivable counts toward revenue, but you don’t receive any cash. Another is depreciation, which is an expense that you subtract from revenue before you get profit, but you don’t actually send out any cash.
Focusing only on revenue and profit can get you stuck in a cash crunch where you can’t pay your employees or make needed investments. This is because, on paper, you’re showing profits, but in the bank, you don’t have the money due to the difference between cash flow and revenue or profit.
Business owners struggle with this issue. The Federal Reserve’s research shows that cash flow is a top challenge for small business owners, where just a 2-month revenue loss can force 86% of companies to cut expenses, take on more debt, or close their doors.
Now that you know why it is important to account for accurate cash flow, below you’ll find information about what cash flow is, how to calculate it, and how to analyze it across operations, financing, and investments. Additionally, you’ll find common questions that business owners ask and their answers.
What is cash flow?
Cash flow, also known as net cash flow, is the total amount of dollars transferred into a business’s bank accounts minus the total amount of dollars sent out. There are two ways to calculate and find your cash flow: your business bank account or your balance sheets.
Business bank accounts:
- Cash flow = Total Dollars Received in Business Bank Accounts – Total Dollars Sent from Business Bank Accounts
Balance sheets from two periods:
- Cash flow = Current Period Balance Sheet Cash – Previous Period Balance Sheet Cash
If the most recent fiscal year’s balance sheet shows $500,000 in cash and the previous fiscal year’s ending balance sheet shows $450,000, then you have positive cash flow of $50,000. Use the cash line item from your balance sheet and not the “cash and cash equivalents” line that includes things like stocks and bonds. If you use them in this calculation, you’ll be double counting items.
Types of Cash Flow in Small Business
There are three types of cash flow in a business that add up to your overall cash flow. You’ll see these on your business’s cash flow statement, which should be visible in your accounting software, or you can get it from your accountant:
- Operating cash flow
- Cash flow from investing
- Cash flow from financing
Operating Cash Flow
Operating cash flow shows the inflows and outflows from your actual business in selling goods or services. It includes all the items that come from or are used in the day-to-day operations of your business. See the examples in the table below:
| Operating Cash Inflows | Operating Cash Outflows |
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One thing to pay attention to is that interest paid on loans is an operating cash flow item because it’s a recurring expense necessary to operate your business. Principal payments and other fees fall into other cash flow types.
While operating cash flow gives you the day-to-day use of cash, financing and investing cash flows show the long-term investment use of your cash and the impact of debt vs equity financing decisions.
Cash Flow from Financing
Cash flow from financing includes all the cash transactions related to funding your business with debt, equity, or other sources, like grants. The table below gives some examples.
| Financing Cash Inflows | Financing Cash Outflows |
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Financing cash flows show how money has moved into and out of the business based on the decisions you’ve made to fund it (i.e., with debt or equity investment). It also shows the amount you’ve paid back to investors and lenders.
Cash Flow from Investing
Cash flow from investing includes the movement of cash for buying and selling assets and any investments your company makes not directly related to your main business.
| Investing Cash Inflows | Investing Cash Outflows |
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Be careful with inventory because it’s easy to confuse selling inventory to regular customers and selling inventory as a one-time bulk sale to a non-customer.
When you make a bulk sale of inventory to a non-customer, it gets counted in investing cash flows. This is because you “invested” with the purchase of inventory and then sold the investment to someone else, making a profit or taking a loss. For example, a trendy clothing store selling leftover merchandise from last season to a discount department store.
Why Cash Flow Is Important for Small Businesses
Cash flow is important for small business owners because it’s the true money you have available to use in your business or take home at the end of the day. Cash flow is different from revenue, profit, and other financial measures that only represent accounting numbers on paper.
If you need cash for wages on payday and you’re waiting on accounts receivable, you’ll see plenty of revenue on paper but you may not have cash in the bank to be able to make payroll. Separating net cash flow into the three different types helps you identify strengths or problems and make better financial decisions going forward.
If you’re constantly generating high amounts of operating cash flow, but it’s offset by negative investing cash flow from buying assets that don’t hold their value (like vehicles or factory machines that wear out quickly), it’s important to keep an eye out for these problems so that you can put a plan in place to fix them.
Understanding the Cash Flow Statement
A cash flow statement is one of three primary financial statements for your business along with the income statement and balance sheet. Accounting software programs will create them for you (check the instructions depending on which one you have) or your finance/accounting professional can create it for you. If you don’t have either, use the formulas below in Excel, Google Sheets, or another spreadsheet program.
Cash flow statements show the three types of cash flow from above in one of two ways:
- Direct method: This adds and subtracts the inflows and outflows like you saw in the above tables.
- Indirect method: Instead of listing direct inflows and outflows, this method starts by taking net income from the income statement and adding back non-cash expenses like depreciation or subtracting changes in items like accounts payable or working capital.
Both methods arrive at the same net cash flow. The direct method is easiest when all you want is overall net cash flow. The indirect method is better for cash flow analysis as it is easier to find problems related to net income and changes in assets.
Here’s how to calculate the types of cash flows with the different methods and tips for how the indirect method helps with analysis.
How to Calculate Operating Cash Flow
To calculate operating cash flow (OCF) with the direct method, you add up the inflows and subtract the outflows. If your business has the items from the table above, your operating cash flow would be:
- OCF = Cash payments from customers and partners – Cash paid to suppliers – Wages – Utilities – Insurance – Interest
The indirect method starts with net income and then adjusts using this formula:
- OCF = Net income + Non-Cash Expenses – Change in Net Operating Working Capital
“Non-cash expenses” like depreciation get subtracted from revenue to decrease profit, but no cash leaves your bank account.
Pro-tip: Double-check you are using the correct total depreciation expense for the cash flow statement if your income statement separates depreciation expense across cost of goods sold (COGS), R&D, and other operating expenses.
Net operating working capital is different from your overall working capital because it excludes cash and cash equivalents from current assets and debt-related items from current liabilities.
| Working Capital | Net Operating Working Capital | |
| Formula | Current Assets – Current Liabilities | Operating Current Assets – Operating Current Liabilities |
| Included Balance Sheet Items | Current Assets
Current Liabilities
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Current Assets
Current Liabilities
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You’ll need both the most recent and the previous period’s balance sheets to calculate the change in net operating working capital for the OCF formula.
When using the indirect method, here are examples of business issues that you might see:
- Receivables issue: When revenues and profits increase but accounts receivable increases fast, it could mean your customers are taking too long to pay or there’s a process issue with your finance team.
- Too much inventory: Seeing changes in inventory grow faster than revenues can mean you’re overstocking, tying up cash in inventory, and not using it for other growth opportunities. And it risks expiring or becoming obsolete.
- Future liquidity issue: Changes in accounts payable and accrued expenses continually increasing? This signals you’re hoping the problem goes away on its own or becomes someone else’s issue. Cash flow might be higher right now, but you’ll eventually have to pay a bill that keeps getting bigger. Unless you can generate more cash in the future, you could be forced to sell valuable assets or go into bankruptcy when that bill comes due.
How to Calculate Cash Flow from Financing
To calculate Cash Flow from Financing (CFF) you can use the same strategy from the direct and indirect methods by summing up cash inflows and outflows from the table below.
| Financing Cash Inflows | Financing Cash Outflows |
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This calculation helps you find cash flow issues if you have profits but are always low on cash. It shows you the excess fees you’re paying or if you’ve been making curtailments.
How to Calculate Cash Flow from Investing
Cash Flow from Investing (CFI) is calculated the same way in direct and indirect methods by adding up cash received from asset sales and investment income and then subtracting cash used to buy new assets or new investments.
If a company sells T-bills for $40,000, spends $50,000 on new equipment, and sells an old car for $7,000, you now have negative cash flow from investing:
- CFI = $40,000 + $7,000 – $50,000 = -$3,000
CFI helps show if you’re investing money wisely. When CFI is more often negative than operating cash flow is positive, it likely means you’re not getting a return on your investments.
Imagine these were your cash flows for the past 5 years, assuming financing cash flows are 0 for this example:
| Year | 1 | 2 | 3 | 4 | 5 |
| Operating Cash Flow | 1,000,000 | 900,000 | 1,100,000 | 800,000 | 900,000 |
| CFI | -3,500,000 | -1,400,000 | 200,000 |
100,000 |
-1,000,000 |
Despite steady operating cash flow totaling $4.7 million, CFI shows a potential problem at -$5.6 million. It is possible heavy upfront investments take a long time to impact the business, but it’s more likely that the heavy upfront investments captured in CFI aren’t generating growth. By comparing these cash flows versus the original investment projections, you’ll know where the problem started so you can fix it.
Frequently Asked Questions about Cash Flow
You’re now ready to calculate cash flow for different scenarios and purposes, as well as apply it to your business. Here are some of the most common questions we see about cash flow and the answers to them.
What is the difference between cash flow and profit?
Cash flow represents the movement of money from one account to the other and profit represents accounting of revenue minus expenses whether actual money has moved or not.
Cash flow is the actual dollars that flow into and out of your company’s bank accounts, whereas profit is what your business earns on paper. Profit equals revenue minus expenses but can be skewed by non-cash items like depreciation where no cash leaves your bank account.
What is the difference between cash flow and revenue?
Revenue is the amount of sales generated even if you haven’t collected the cash, but cash flow includes only dollars that have come into (or left) your bank accounts.
Revenue includes accounts receivable (sales where you haven’t received cash). When accounts receivable is greater than 0, revenue will be higher than the cash flow you receive from sales. Cash flow also includes expenses, investing activities, financing activities, and other non-revenue items.
What is cash flow forecasting?
Cash flow forecasting is the process of estimating the future inflows and outflows of cash for your business based on potential future income statements and changes to your balance sheet. It helps you identify whether you’ll have enough cash in the bank to cover costs or if you’ll need to get more. By forecasting, you can avoid problems like not being able to pay employees or damaging supplier relationships, because you can plan by taking on financing.
