How to calculate cash flow – the ultimate guide

Running out of money is the most likely reason your business will fail. Cash is the lifeblood of any business, and this can be especially difficult for small startup enterprises without a large customer base or a lot of capital to start.

This is why calculating cash flow is so important. You are monitoring your business’s vital signs by paying attention to the ways money is flowing in and out of it.

To help you with this, we’ve put together a post on how to calculate cash flow. We’ll go into detail about the importance of it, before outlining the different types of cash flow and providing examples of the calculations.

Calculating different types of cash flow for your business will give you the clearest picture of its financial health. There’s more you can learn than simply calculating net cash flow. For instance, calculating operating cash flow will help you understand the daily movements of money in your business, or calculating free cash flow will give you an idea of what is left over to pay to creditors and investors.

To return to the vital signs metaphor, determining the health of a person doesn’t mean conducting one test only. Circulatory, respiratory, and neurological functions can all contribute to a potential disease or condition. The same goes with better understanding your business. Look at all your cash flows to form the most comprehensive picture, and use this to identify any existing problems.

Net cash flow is your biggest indicator of the financial health of your business. It determines the difference between all the other cash flows, giving you an overall picture of the money flowing in and out of your business.

Calculating cash flow is ideally the first cash flow calculation you do. It will determine how your business is performing overall, over a given period of time.

Your net cash flow is comprised of three different categories:

• Operating activities: the capital you generate and use for basic operations, daily expenditures, administrative costs, etc.
• Financial activities: capital generated through debt or other financial agreements, cash used to pay off debts, etc.
• Investing activities: capital gained from investments

The formula for calculating net cash flow is shown in the following:

Net cash flow from operating activities + net cash flow from financial activities + net cash flow from financial activities = net cash flow

When calculating, subtract the outgoing total cash outflows from the total cash inflows. Let’s look at an example below for clarity.

Weyland-Yutani Corporation has a net cash flow of the following:

• €100,000 from operating activities
• €40,000 from financial activities
• €60,000 from losses on investments

100,000 + 40,000 - 60,000 = 80,000

Weyland-Yutani corporation’s net cash flow is therefore €80,000 per year. This is relatively strong for a business, allowing it enough room to invest in new products or pay off debts.

Operating cash flow is profits generated by daily activities. This is the first section in your cash flow statement you will present, and determines if profitability is consistent enough to maintain and grow operations, i.e. improve conditions and efficiency.

OCF is revenue minus expenses. In the simplest sense, it is calculated like this:

Total cash received from sales - cash paid for operating expenses = operating cash flow

To obtain a more precise figure, you can adjust for things like depreciation, increases in pricing or wage costs, and non-operating expenses that affect the overall figure.

Oscorp has earned a gross income of €1,000,000 from the fiscal year. They spent €50,000 in operating expenses, which for Oscorp includes equipment repairs, shipping costs, etc. Tax costs come to €250,000. Depreciation costs come to €10,000.

From this, Oscorp’s operating cash flow is calculated by subtracting operating expenses from taxation costs, bringing the net income total to €700,000. To determine the OCF, you lastly add the depreciation costs, bringing the total to €710,000 per year.

Free cash flow is the cash in hand you’re left with after having paid all your expenses. It can be seen as the cash you’re most able to play around with, possibly for growth opportunities with your business. Investors can also use this figure to estimate the financial health of your company. Think of it as true profitability.

To calculate your free cash flow, you need to have already calculated your operating cash flow. Free cash flow is determined with this equation:

Operating cash flow - capital expenditure = free cash flow

Globex Corporation produces luxury hammocks, and has a capital expenditure of €2,000, with an operating cash flow of €3,200.

3,200 - 2,000 = 1,200

Globex Corporation’s free cash flow amounts to €1,200.

Financing activities have to do with your debt payments, equity payments, and dividends. In a financial statement, your financing cash flow will give investors an idea of how your company manages at paying off its debts and financing activities.

You may demonstrate a strong net cash flow and operating cash flow, but if your financing cash flow demonstrates instability, you’re likely to scare investors off.

Calculating cash flow from financing activities is relatively simple. It means adding together all of the above financing costs and producing the result. If your debts are paid and equity financed, you will end up with a positive financing cash flow.

Issue/repurchase equity + issue/repurchase debt + dividends payments and other items = financing cash flow

MomCorp manufactures robots and robot oil. The company has investments in AI technologies, raw material production, and fossil fuels.

To determine the cash flow, the payouts from these investments, as well as stocks held and sold, must be added and subtracted accordingly. MomCorp’s resulting cash flow will be a net cash flow result from these financing activities.

Your cash flow from investing activities determines how much cash you’ve generated from various investments and investment-related activities. Investments include purchasing of physical assets, investments in securities, or the selling of securities or assets.

Calculating investing cash flow requires adding together your earnings from investments and subtracting for depreciation over the year.

Skynet has made a number of investments into AI technology amounting to the following net figures:

• Purchases of marketable securities 21,902
• Proceeds from maturities of marketable securities 26,783
• Proceeds from sales of marketable securities 49,516
• Payments for acquisition of property, plant, and equipment 7,718

Adding the proceeds and subtracting the purchases brings Skynet’s investing cash flow to the following figure: €46,679

With a discounted cash flow analysis, you can determine the present value of future cash flows. Such an analysis is usually useful for deriving the value of investments because you estimate the payoff in the future, at the time of making the investment.

The idea behind discounted cash flow is to determine whether the calculated value of the investment is higher than the current cost. To determine the discounted rate, use the weighted average cost of capital (WACC). Your WACC is the average rate of return shareholders expect for a given year, and usually expressed as a percentage.

The formula for DCF is as follows:

Cash flow / 1 + WACC

This is then added on year by year.

Teamocil has a WACC of 5% and is investing in a new project worth €11 million, lasting 5 years.

With DCF, the discounted cash flow for Teamocil’s project produces the following figures, rounded to the nearest euro:

Your cash flow forecast is your attempt to anticipate cash inflows and outflows for a future period. This is done in order to determine whether the business has sufficient funds to continue carrying out its activities.

Cash flow forecasts are usually forecasted over 12 month periods and monitored over weekly or monthly periods, depending on the size of the business.

Calculating cash flow forecasts can be done in both the indirect method and the direct method.

Indirect method: for long-term forecasting, this is derived from your income statement, balance sheet, and working capital changes.

Direct method: short-term forecasting, anticipating direct inflows and outflows, generally using receipts and payments.

The Figgis Agency, a private detective agency, forecasts its cash flow for three months based on these inputs. The Figgis Agency’s opening balance is $450.

First three months revenue (75% cases paid in cash, 25% in credit – credit period is one month):

• Jan €2,500
• Feb €3,000
• March €4,000

Travel expenses (80% paid in cash, 20% in credit, – credit period is two months):

• Jan €200
• Feb €150
• March €175

Other expenses (20% in credit – credit period is two months, 80% in cash):

• Jan €200
• Feb €220
• March €170

Forecasting is then a simple procedure of determining the net cash flow from the inflows and outflows, and monitoring these results through the months as the Figgis Agency operates.