The concept of “net cash flow” reflects the amount of cash generated or lost by a company during a specific period. The periods of calculating may be different: week, month, quarter, annual. In simple words, the concept reflects a business’s cash inflow and outflow during a given period.
The net cash flow may also represent the difference between opening and closing cash balances over a specific reporting period. The formula to calculate net cash flow includes all business operations, investments, and financing.
Keep reading our article to learn more about the importance of cash flow and how to calculate it. This guide should help you better understand the formula and how to calculate your net cash flow by checking a comprehensive example.
What is Cash Flow?
Before diving into the detail of calculating net cash flow, let’s find out what a cash flow is. The cash flow is the term that determines the movement of money (in and out) within the business.
Understanding Net Cash Flow
Net cash flow (NCF) shows the difference between money coming in and out of business during a given period. When the company is making a profit, NCF is positive. But if a company is losing money, the NCF is negative.
In terms of NCF, there are two concepts: inflow and outflow. The first is related to money coming in, and the second reflects money going out. NCF comes from three main business activities:
- Operating.
- Financing.
- Investment.
Businesses can analyze NCF in isolation and compare it with other periods. It’s critical to do both. Analyzing periods in isolation gives management an understanding of how good or bad the business is doing. The comparison method provides companies with a long-term perspective.
It’s important to aim at a positive NCF, but it’s not a failure if the company has one or several negative periods. Negative NCF may occur due to buying expensive equipment, buildings, investing in something, etc. Eventually, these investments generate positive NCF.
Is Net Cash Flow Different from Net Income?
These two concepts have significant differences. The NCF reflects how much operating money moves in and out during a specific period. But net income also includes expenses.
Unlike NCF, net income also substracts non-operating expenses, such as depreciation, taxes, amortization, etc. Net income is when the business pays all of these expenses. It means that the number should be positive. If the number is negative, it means the company experiences losses.
Net income is more about giving a bigger picture of a company’s profitability. The NCF shows the business’s ability to earn income from standard business activities.
Net Cash Flow Formula
The formula looks as follows:
Operating activity cash flow (CFO) + financing activity cash flow (CFF) + investment activity cash flow (CFI) = net cash flow
To calculate CFO, CFI, and CFF to measure the NCF, determine the outflow:
- Labor costs.
- Vendor and supplier payments.
- Any taxes.
- Fees, penalties, etc.
- Paid licenses.
- Interest a company has to pay.
- Transportation and fuel costs.
- Utilities.
- Rent.
- Debts payments paid.
- Marketing and advertising expenses.
- Equity investment.
- Shareholder (dividends) payout.
- Any property purchase expense, including buildings, equipment, machinery.
- Back stocks purchases.
Inflow gains are:
- Payments received from customers.
- Sales of items or services.
- Cash dividends from investments.
- Any interest earned.
- Sales of fixed assets.
- Loan receipts.
- Vendor or supplier refunds.
- Grant payments.
- Funding from third parties.
- Payments received from lawsuit settlements.
- Any insurance claims
- Sales of property or equipment
- Any other form of cash a company generates.
Most of the mentioned data company owners may find in their balance sheets.
Calculating Net Cash Flow
You may either use the provided above formula or the one below. The first one is more detailed. But if you don’t have a very detailed balance sheet due to a lower number of business operations, you may consider a simpler formula:
cash receipts – cash payments = net cash flow
Figure out all your payments and expenses in cash, and subtract expenses from received cash. To better understand how to use the first formula, check the following example.
Calculation Example
As mentioned, we have prepared a calculating example to understand better how to use the formula for your business. The RetailCompany (fake name) wants to calculate its net cash flow. The accountant has to do the following actions.
Determine Cash Flow from Operating Activities
The formula states that a company must first calculate operating activities. The accountant must determine cash the company has generated thanks to operational activities during a given period:
- any cash a company received;
- dividends;
- any interest accrued;
- money generated thanks to sales or providing services.
Now the accountant should determine the outflow of money. It includes:
- labor expenses;
- money a company spends on assets;
- repairs;
- payments to suppliers;
- loans a business takes and pays to cover them;
- transport costs;
- insurances;
- dividends a business pays.
The list may be extended, but the key takeaway is that the outflow of money contains costs a company must pay. It’s also worth noting that different businesses may have different operational activities that generate flow and outflow.
Suppose, RetailCompany generates income from the following operational activities:
- Sale of products: $300,000
- Cash interest: $90,000
RetailCompany also has the following outflows:
- Labor expenses: $30,000
- Payments to suppliers: $50,000
- Warehouse maintenance: $25,000
- Transport costs: $12,000
So, the operating cash flow means subtracting all operating outflow from all operating income:
($300,000 + $90,000) – ($30,000 + $50,000 + $25,000 + $12,000) = $273,000
Determine Financing Activities
Now RetailCompany must determine financial activities, including gains and losses. The list may include:
- any gains from investing in stocks, bonds, other investments;
- any losses from investing.
If RetailCompany decides to invest, it may get gains or losses. RetailCompany has several investments, and now it has received $40,000 and lost $5,000 in investment.
The result of financing activity is $40,000 + (-$5,000) = $35,000.
Investing Activities
RetailCompany now has to determine income generated from some investing activities. The list may include:
- Money generated from principal notes, the sale of bonds or machinery, equity, etc.
- Money outflows, such as payments to get assets or cover debts, equity interest, purchasing assets like equipment or machinery, etc.
RetailCompany has generated income from selling equipment and avoided any invest outflows. The business generated $15,000 and $5,000. Investing activities bring:
$15,000 + $5,000 = $20,000
Determine Net Cash Flow
According to the formula posted above in the article, the person responsible for accounting in RetailCompany must add all three figures:
$273,000 + $35,000 + $20,000 = $328,000
As mentioned, cash flow may be positive or negative. Luckily for RetailCompany, it has a positive number.
The Bottom Line
The NCF provides the company’s management with information about the current financial situation. It’s crucial to analyze NCF as separate periods and in comparison. Negative NCF may indicate that the company invested in something. The comparative method gives a clearer picture.
If you still have trouble with understanding how to calculate total net cash flow, you may consider finding and downloading a free MS Office Excel template. There are a lot of useful resources on the web that may be helpful. You may also consider choosing a course to analyze and calculate net cash flow. There are many free online courses that give comprehensive explanations. Or ask for professional help.
