Cash flow is the movement of money in and out of a business over a period of time. It shows the company’s liquidity, and how well it can cover expenses, investments and other financial obligations. Cash flow can be broken down into operating, investing and financing activities, all of which contribute to the overall health of a business.
Content Outline
Formula and Calculation of Cash Flow
Cash Flow Formula
Cash Flow = Cash Inflow – Cash Outflow
Cash flow can break down into three main areas, each with its formula:
1. Operating Cash Flow
Operating Cash Flow = Net Income + Non-Cash Expenses (e.g. Depreciation) + Changes in Working Capital
Operating cash flow is cash from the company’s core business activities.
2. Investing Cash Flow
Investing Cash Flow = Cash from Sales of Investments – Cash Spent on Capital Expenditures (CapEx)
This is cash used for investments in assets like equipment or long-term investments.
3. Financing Cash Flow
Financing Cash Flow = Cash from Borrowings or Issuance of Stock – Dividends Paid and Debt Repayment
This is cash raised or repaid through debt and equity financing.
Key Takeaways for Cash Flow
Liquidity Measure
Cash flow is a measure of a business’s financial health whether it can meet its short-term obligations.
Positive vs. Negative Cash Flow
Positive cash flow means inflows are greater than outflows, and negative cash flow means more money is going out of the business than coming in.
Cash Flow vs. Profit
Cash flow is different from profit, profit includes non-cash expenses like depreciation, and cash flow only looks at actual cash movement.
Investment and Growth
Healthy cash flow allows businesses to invest in growth opportunities, expand operations or acquire new assets.
Why is Cash Flow Management Important?
Cash flow management is important because it ensures a business has enough liquidity to cover operational costs, payroll, debt repayments and other financial obligations. Good cash flow management helps businesses avoid liquidity crises, builds financial resilience and plans for future growth.
- Avoid Insolvency: Bad cash flow management can lead to cash shortages even if the business is profitable and can lead to insolvency.
- Strategic Decision Making: Good cash flow management allows businesses to make informed investment and operational decisions and have capital when needed.
- Smooth Operations: Positive cash flow means day-to-day business operations are not disrupted by lack of funds.
Types of Cash Flow
- Operating Cash Flow
Cash generated or used by the company’s core business activities. It is a direct measure of cash from sales and services. - Investing Cash Flow
Cash movements related to the purchase or sale of long-term assets like property, equipment or investments in other businesses. It includes capital expenditure and proceeds from the sale of investments. - Financing Cash Flow
Cash is received from debt or equity and cash is used to repay debt or distribute dividends. It shows the company’s activities with shareholders and creditors.
Example of Cash Flow
Example:
ABC Corp. is a retail business. In a quarter:
- It makes $150,000 in cash from sales.
- It pays $50,000 in salaries, $20,000 in rent and $10,000 in supplies.
- It invests $30,000 in new equipment.
- It issues $40,000 in new stock.
To calculate cash flow:
- Operating Cash Flow:
Cash from sales ($150,000) minus operating expenses ($50,000 + $20,000 + $10,000) = $70,000 - Investing Cash Flow:
Cash spent on equipment = -$30,000 - Financing Cash Flow:
Cash from issuing stock = $40,000
Net Cash Flow:
Operating Cash Flow ($70,000) + Investing Cash Flow (-$30,000) + Financing Cash Flow ($40,000) = $80,000
ABC Corp. has $80,000 in cash for the quarter.
Cash flow management is key to a business being financially healthy, to pursue growth and to meet financial obligations.
Read What Is Negative Cash Flow?
Read What Is Positive Cash Flow?
Read What Is A Cash Flow Statement?