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How To Calculate Cash Flow For Your Business

Learn what cash flow is, how to calculate it, and why it matters to a healthy, sustainable business.

Run your Business
Finances

By Pipe October 27, 2023

It's an incredible achievement to see your products generating revenue. However, assessing your financial health goes beyond just focusing on profits.

It's crucial to take into account all the inflows and outflows of cash within your business. If your cash expenses are more than cash coming in the door at any given point, you run the risk of not being able to keep those doors open.

That's where cash flow comes in. It's like a financial health check for your company. It tells you whether you can meet your financial obligations and keep things going. Understanding your cash flow is essential to keeping your business on solid ground.

In this guide, we'll walk you through each step of the cash flow calculation, explain what each component means, and share some practical tips to help you manage your cash flow like a pro.

Before we proceed, here are some basic definitions to keep handy:

Cash flow provides valuable insights into the overall financial health of your business. A cash flow statement tracks the inflow and outflow of money over a specific period, be it weekly, monthly, or yearly.

Gross revenue merely reflects how well your products and services are being sold. On the other hand, cash flow offers a comprehensive view of your company's ability to sustain itself.

Positive cash flow indicates that your business generates more cash than it spends.

Negative cash flow indicates that you’re spending cash faster than you’re bringing it in.

What is Cash flow?

Cash flow refers to the movement of money into and out of a business or organization over a specific period, typically measured on a weekly, monthly, or yearly basis. It's a snapshot of your financial health, showing you how much cash is coming in and how much is going out.

It provides a clear picture of the cash generated from operating activities, as well as the cash used for investments and financing activities.

Now, let's talk about why cash flow matters. For small business owners and founders like you, it's essential to have a clear picture of your company's financial obligations. Cash flow gives you that insight. It tells you if your business can meet its financial commitments, like paying suppliers and covering expenses. By tracking cash flow, businesses can gain insights into their liquidity, manage their working capital effectively, and make informed decisions ab out budgeting, investment, and growth.

Many business owners make the mistake of assuming revenue or profit generated is the same thing as cash flow, but this is false. Cash flow provides a more holistic view. It goes beyond sales and gives you a comprehensive understanding of your company's ability to sustain itself.

Let's take a moment to clarify some important cash flow definitions before diving into our calculations:

  • Net cash flow gives you a comprehensive overview of the cash flowing in and out of your business within a specific time period. It shows you how much cash you have remaining to work with after all transactions are accounted for.

  • Operating cash flow helps you gauge how effectively your business generates cash from its day-to-day operations, such as product sales, wages, and inventory. It gives you insights into your business's core financial performance.

  • Investment cash flow involves the money your company earns or spends on long-term investments and company assets. This category involves cash flows related to the buying and selling of long-term assets, investments, and other non-current items. Understanding this aspect helps you evaluate the impact of your investment decisions on your overall cash flow.

  • Financing cash flow revolves around how a company raises and repays money. It includes activities like taking loans, issuing or buying back company shares, paying dividends to shareholders, and repaying debts. It sheds light on how your financial decisions affect your cash position.

  • Free cash flow represents the money that remains available to spend after covering your expenses. It provides you with financial flexibility to invest, expand, or handle unforeseen circumstances.

  • Cash flow ratio is a calculation that reveals how many times you can pay off your current debts within a specific period using the cash generated in the same period. It serves as a measure of your business's ability to meet its debt obligations.

How do you calculate cash flow?

Your cash flow is a measure of how much cash flows in and out of your business, so to calculate it, you need to look at your total cash inflow and outflow and find the difference. Here’s a simple formula for doing so:

Net Cash Flow = Total Cash Inflow - Total Cash Outflow

To break it down further:

1. Determine Cash Inflows:

  • Include cash received from sales, customer payments, or any other sources of cash coming into your business during the given period.

  • This can also include interest earned, dividends received, or any other income generated from investments or financing activities.

2. Calculate Cash Outflows:

  • Consider all the cash payments made by your business during the specified period.

  • Include expenses such as salaries, rent, utilities, raw materials, inventory purchases, equipment costs, loan repayments, taxes, and any other cash payments.

Subtract Cash Outflows from Cash Inflows:

  • Subtract the total cash outflows from the total cash inflows to determine the net cash flow.

  • A positive net cash flow indicates that your business has more cash coming in than going out, which is generally desirable.

  • A negative net cash flow suggests that your business is spending more cash than it is generating, which may require attention to improve cash flow management.

While net cash flow gives you an overall picture, you can also look specifically at cash flow from operating activities, financing activities, and investing activities. Now, let’s go into how to calculate the figures for each:

Operating cash flow

Start by calculating your cash flow from operating activities, which represents the money generated and spent as a result of your primary business operations.

There are two approaches to obtaining the numbers for operating cash flow: direct and indirect cash flow.

  • Indirect cash flow involves adjusting your net income based on operating activities. Begin with your net income and make adjustments for any non-cash activities that would impact your revenue and net income but not your cash position. Consider changes in working capital accounts like inventory, accounts payable, and accounts receivable, which can all indicate sales or expenses not involving cash. This method is often preferred because it aligns with accrual accounting, which is commonly used in businesses.

  • Direct cash flow focuses on cash transactions, specifically cash received from customers and paid to vendors while excluding non-cash payments. While this method provides a clearer picture of actual cash movements, it’s cumbersome for all but the smallest and simplest businesses because there will be a lot of transactions to account for.

To calculate operating cash flow with the indirect method, you'll need your net income, non-cash expenses, and changes in working capital (company assets). The formula for operating cash flow is:

Operating Cash Flow = Net Revenue + Non-Cash Expenses - Net Increases in Working Capital

Investing cash flow

Next, calculate your cash flow from assets and investing activities. Determine how much money your company spends and earns from investment activities, such as equipment purchases and sales, property acquisitions, business acquisitions, and marketable securities.

Once you have the details of your business investments, calculate your investing cash flow:

Investing Cash Flow = Revenue From Investing Activities - Losses From Investing Activities

Financing cash flow

Lastly, calculate your financing cash flow by considering your company's financing activities, including interest/loan payments, funds raised from equity distribution and loans, and dividend payments (if applicable for publicly traded companies).

Once you have these details, use the following formula to determine your financing cash flow:

Financing Cash Flow = Cash Received From Loans and Equity Raises - Loan Repayments - Dividend Payments

By analyzing each of these cash flow components, you can gain valuable insights into your business's cash flow dynamics and identify areas for improvement or optimization.

Analyzing and evaluating cash flow metrics

You've mastered the fundamentals of cash flow. But that’s not all you need to know. You also need to know how to interpret cash flow for your business in order to know what’s good, what’s bad, and how you compare to others in your industry. We’ll look at a key cash flow metric next: cash flow ratio.

Cash flow ratio

Analyzing your cash flow ratio is a vital aspect of evaluating your company's financial standing. The cash flow ratio provides a measure of your business's liquidity by comparing your cash flow to your liabilities. It helps assess how well your company can meet its short-term financial obligations and indicates its ability to handle unexpected expenses or downturns in the market.

Once you've calculated the different types of cash flow, you can use the cash flow ratio formula to assess your company's liquidity. To calculate the cash flow ratio, simply divide your cash flow by your liabilities. This can be done using your overall cash flow or by analyzing specific forms of cash flow, such as operational, investing, or financial activities. 

Cash Flow Ratio = Cash Flow / Liabilities

If your ratio is less than one, it indicates that your company needs to reduce expenses to improve cash flow. Without making any changes, you risk depleting your cash reserves.

On the other hand, a ratio higher than one signifies that your company is generating enough cash to meet its current liabilities. However, if the ratio is excessively high, it may indicate the need to reinvest in your business to foster growth.

Analyzing and evaluating cash flow metrics, like cash flow ratio, and using them as part of your financial analysis toolkit, can help you effectively manage your cash flow, make informed decisions, and ensure the long-term success of your business.

Tips for maximizing your cash flow

Now that you have a solid understanding of how to go about calculating your cash flow, let's explore some effective strategies to maximize it. Use the cash flow management tips below to better your company’s financial performance.

Stay on top of your invoices

Invoices can often be a major drain on cash flow. While you may make sales, if customers don’t pay in a timely manner, it can lead to unexpected slowdowns in your business operations.

To mitigate this, it's essential to stay on top of your invoices. Regularly audit unpaid invoices and follow up with customers to ensure timely payments. Consider shortening your payment terms to improve cash flow. As your business grows and gains reliable customers, you can offer longer net terms to accommodate their needs.

To encourage prompt payments, consider sending payment reminders before the due dates, offering incentives for early payments, providing multiple payment options, accepting partial up-front payments, and establishing stricter credit policies to avoid giving overly generous terms to customers who are unlikely to pay on time.

Reduce Expenses

Keeping a close eye on your business expenses is crucial. Without regularly auditing your cash outflows, you risk wasting money on unnecessary expenses, which can significantly impact your cash flow.

This is especially true for smaller purchases. Pay attention to them, as they can add up over time. A few small purchases here and there isn’t a big deal, but if you make a ton of small buys, they can drastically increase your business expenses. Review your expenses to identify areas where you can cut back without compromising the quality or efficiency of your operations. 

Here are a few additional items to consider looking at when cutting expenses:

  • Consider downsizing your office space if you have unused or underutilized areas.

  • Optimize your inventory management to reduce excess stock

  • Consider liquidating old inventory to generate quick cash and free up resources.

  • Another effective strategy is to invest in automation where possible. Look for software solutions that can streamline tasks and reduce the need for manual labor. By eliminating redundant work, you can boost productivity, save time, and reduce costs.

Look for financing options

Your company’s cash flow is more than the money you generate from income and investments. It also includes the money you bring in due to financing—whether dilutive funding through equity or non-dilutive sources like loans.

Financing your operation will help you access the money you will receive in the future. By securing additional funding, you can access capital to support growth initiatives, marketing activities, inventory purchases, and hiring.

Consider different financing options based on your specific needs. For instance, equity financing can be a viable choice if you're looking for a partner to support your business. The person offering financing takes a stake in the business and has a vested interest in helping it grow.

Traditional loans, such as bank loans, invoice financing, and equipment financing, are also an option if you don’t want to give away equity. 

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Collaborate with your vendors

Vendor costs can be a significant drain on your business, especially for product-based companies. The money tied up in inventory can impact your cash flow negatively if sales are not swift. You’ll spend a lot of cash to get the inventory you need, and if you don’t sell quickly, your money gets tied up in your warehouse.

For online businesses, technology vendors play a crucial role, and their costs can quickly add up if you’re not careful.

This is why you want to regularly review your spending with vendors to identify opportunities for cost savings. If you purchase large enough inventory, you may want to consider negotiating pricing discounts based on volume. If you're not tied to specific vendors, then shopping around to find better deals is a great place to start.

Earlier, we talked about shortening payment terms for customers to help speed up cash inflows. If you have a solid relationship with your vendors, you can also negotiate longer payment terms to help with outflows as well, giving you more flexibility.

Create cash flow forecasts

To anticipate and plan for future cash flow, consider creating cash flow forecasts. These projections allow you to estimate the cash flow your business can expect based on historical data, market trends, and anticipated business growth.

Here is some important information to keep in mind when making cash flow projections:

  • Review past cash flow: Take a look at your cash flow statements from previous periods. This will give you insights into how money flowed in and out of your business in the past.

  • Study market trends: Stay updated on market trends that can affect your business. Understand how seasonal changes or industry shifts may impact your future sales and cash flow.

  • Estimate business growth: If you're planning investments or expecting growth in your business, consider how these factors will influence your cash flow. Will they bring in more revenue? Will they require additional expenses?

By combining these factors, you can create projections that will help guide your decision-making process.

For instance, let's say you have a new product launch coming up. By analyzing your future cash flow, you can determine how much available cash you'll have for your marketing budget. This way, you can allocate your resources wisely and focus on the marketing channels that help you get the most out of your ad dollars. You can also use tools like QuickBooks Online, or specialized cash flow forecasting software to create detailed forecasts. 

Conclusion

Understanding your company’s cash flow helps you make smarter business decisions. When you know how much is coming in, going out, and any gaps between the two, you’ll be better prepared to make the most of your cash and take advantage of every opportunity. 

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