Cash flow is a calculation that helps you understand how much money you have. It seems simple enough: This number represents the money that comes in or goes out of a business. (It can also be applied to personal finance.)
In actuality, these calculations can be incredibly complex. When businesses have large amounts of money invested in research and development, or have spent a lot on real estate or equipment, it can be incredibly difficult to calculate just how much money is actually going into or coming out of the business, and how viable the business is moving forward. Cash flow statements exist to look at the overall health of your business, and to do that, there’s a lot that these statements need to take into account.
In this article we’ll look at cash flow, and how it applies to both business and personal finance. We’ll give a glossary of terms that are used to conduct a cash flow analysis, and explain how it is calculated. Finally, we’ll look at a cash flow statement and everything that goes into it. By the end of this article, you should have a deeper understanding of cash flow and how it can show you the overall health of your business.
What Is Cash Flow?
Cash flow is the total amount of money coming into and leaving a business. For small businesses, it can be calculated somewhat easily by using a basic balance sheet to subtract expenses from income, which will give you profit. For larger companies with complex financing activities, a large amount of cash coming in from different business ventures, and a large amount of working capital, it can be incredibly complex to calculate and require a team of financial analysts to figure it out.
This concept isn’t just for businesses. It can also be a term for personal finance, and simply refers to how much money is being spent vs. how much money is being earned.
Positive vs. Negative Cash Flow
Cash flow is calculated by looking at money going in and money going out, or positive and negative cash flow. Sometimes this is called cash inflow and cash outflow.
Marketing expenses, money spent on operating activities, investment losses, and financing activities, all count toward cash outflow. Cash inflow usually comes from sales, but can also come from licensing, partnerships, investment gains, or any other revenue source.
Obviously enough, healthy businesses tend to have an overall positive number. A negative number is fine for a short term accounting period and can even be fine for a long period of time, especially for a growing company or one that’s looking to expand rapidly and innovate. However, eventually, businesses will need to start bringing in revenue and holding a positive cash flow.
What Is Cash Flow for Business vs. Personal Finance?
This term can be applied to both businesses and personal finance. For small business owners, a cash flow analysis allows them to see all the money that’s going into and out of a business, whether it be in employment costs, investment, capital expenditures, or money coming into your accounts receivable.
In personal finance, this analysis can be applied to figure out monthly expenditures vs. income and to make sure you’re living a healthy lifestyle. If you have multiple sources of income from side hustles, performing an analysis can help you calculate how much you’ll owe in income taxes at the end of the year.
In either business or personal finance, a line of credit can work as a way of financing if you don’t have enough cash. For individuals, that’s as simple as putting a charge on a credit card as opposed to withdrawing it from your bank account. But as always, taking out credit increases your financial obligations and may affect future cash flow.
Glossary of Terms
Before we dive into performing calculations and creating statements for a business, we should look at some terms surrounding these statements and define them.
Operating Cash Flow
Operating cash flow is the amount of cash a business generates in its normal operations. This is the money coming in vs. the money spent on operating expenses, such as employee pay, electricity to keep a shop or office open, etc.
Businesses that survive have a positive number here.
Capital expenditure is money that is spent by a business to get or keep fixed assets, i.e. stuff that requires a big up-front investment but then won’t require more money to maintain. Think: land, computers, machinery, office buildings, etc. Even if businesses have a positive operating cash flow, they may need to take out a line of credit to get the money they need for capital expenditures.
Free Cash Flow
Free cash flow is the amount of cash that is “free” for a business to spend as it sees fit. It’s calculated by taking operating cash flow and subtracting capital expenditures. So even if a business makes $10 million a year in net profit, if it has $5 million tied up in capital expenditures, its free cash flow is $5 million. This is money that can be reinvested in the business or saved as profit for a rainy day.
Cash balance is the amount of money in an account on hand. If a business has a bad quarter, but has been thrifty and has a large cash balance, they can survive a downturn.
Cash equivalents are non cash items that can be quickly converted into spendable money. Selling a large amount of land takes time, but cash and cash equivalents are assets that can be spent, or converted to spendable cash, quickly.
How to Calculate Cash Flow
In personal finance, these calculations don’t require a complicated financial analysis. You look at what you spend, compare that to what you make, add any savings or subtract any recurring loan payments, and you’ve figured it out. There are templates to help you do so in Microsoft Excel and Google Sheets.
Depending on the size of a business, doing a company’s calculations can be a job for an entire team of accountants and financial analysts. But these calculations can help determine a company’s profit margin by figuring out the amount of actual cash (or net amount) coming into a business in a net cash flow analysis. This analysis can look at a period of time (fiscal quarter, year, decade) and calculate a closing balance for that period. It will factor in current assets, R&D, financing complications, and more.
The basic way to calculate this number for a business is to take your net income (income minus operating expenses) over a period of time. For small businesses, it can be that simple. For larger businesses, you will probably need to create a comprehensive statement to more accurately calculate your business’s cash flow.
What Is a Cash Flow Statement?
A cash flow statement looks at all of your business activities to calculate a total. Put simply, this statement shows how much cash your business has.
But again, depending on the size of the business, these statements can vary wildly in complexity. A company’s cash flow statement will follow generally accepted accounting principles and can be as simple as income vs. expenses. But for many, these statements will take several things into account in several different sections: cash flow from operating activities, from investing activities, and from financing activities.
The cash flow from operations (or cash flow from operating activities) section of your statement will look at the main revenue-generating part of a business. It will take a look at a business’s basic income statement and balance sheet to see how much money is moving into or out of the business. Cash and cash equivalents will typically be listed in this section.
This section of the statement will look at long-term assets and other major investments a company has made. Research and development, long term investment plans, and other non-current assets will be listed here.
This section will look at the cash flows that will affect any bonds, stocks, or dividends connected to the company. Basically, this section considers how the money a business is making will affect those who are helping finance it, in whatever form that may take.
Having these three sections gives you a more comprehensive understanding of a business’s finances. While it would be simpler if you could run an equation and just get one number, you need to factor in several things when understanding most businesses’ finances.
Understanding Cash Flow in Small Businesses
Cash flow is a simple concept — how much money is going into or out of a business — that can take wildly complex forms. Depending on the size of the company, and the complexity of its holdings and revenue opportunities, it can take a small army of accountants to figure out what this number is.
For most small businesses, however, these calculations are much simpler. And understanding how cash flow works, and how to calculate it, can give you a better overall understanding of the health and long term viability of your business.