Cash flow, or the net balance of money moving in and out of your accounts, is the lifeblood of any business. You need a steady stream of cash flow to keep the lights on, the bills paid and your employees happy. Tracking cash flow can help you understand how money moves through your business and may even help you reduce expenses. Read on to find out how to do it.
Why is cash flow important to a small business?
There are a variety of reasons you might want to calculate your business’s cash flow. With robust cash flow reporting, you can:
- Demonstrate your profitability
- Support your business expansion
- Improve your chances of receiving a business loan
- Ensure your ability to pay for expenses
- Improve your cash management
There are many ways to analyze your finances — profit and loss statements, balance sheets and income statements — and it’s a good idea to use more than one because each highlights a different aspect of your company’s financial health. When you measure your cash flow, you measure your underlying liquidity, or your ability to turn your business assets into actual income. You also demonstrate your solvency (aka your capacity to cover debts) during a certain period of time, typically from week to week or month to month. Used in conjunction with other types of reports, they can provide a full picture of how money flows through your company.
Types of cash flow formulas
If you want a simple understanding of the money coming in and going out of your business, a straightforward formula is all you need. A basic monthly cash flow formula includes:
- Starting capital
- Cash coming into the business (cash inflow)
- Cash going out of the business (cash outflow)
- Your ending balance
To create a monthly cash flow calculation, for example, you would start with the capital you had at the end of the previous month. From there, you would add the money you made during the month you’re measuring but subtract the amount spent. What you’re left with helps you better understand what you’re making and spending.
But that’s just the beginning. There are several more ways to calculate cash flow:
Free cash flow formula
Think of free cash flow as your business’s spending money after all the bills are paid. It’s the cash you can use to pay off debts, give back to your investors or put into growing your business. Here’s how to figure it out:
- Free Cash Flow = Current Operating Cash Flow − Capital Investment Expenditures
Operating cash flow formula
Operating cash flow helps you show investors (or skeptical friends and relatives!) your business’s earnings from normal business operations over a fixed period of time. This calculation tallies your revenue minus costs, taxes and interest paid on debts. You could also think of it as your profits after you’ve settled up your costs, taxes and debt payments:
- Operating Cash Flow = Net Income + Depreciation & Amortization + Any extra income − Net Increase in Working Capital
Available cash flow formula
This formula shows how much liquidity is available for investors or others to access without affecting the company’s daily operations. More simply, it tells you how much money you can pull out of your pocket and spend without disrupting the flow of your business. It calculates earnings before interest, taxes, depreciation and amortization (commonly known as EBITDA):
- Available Cash Flow = Net Income From Operations + Interest + Amortization & Depreciation
Cash flow forecast
Cash flow forecasts can help you predict future cash flow for a set period of time. Consider them a useful tool for planning big purchases, figuring out when to pay back creditors and investors or funding your next big move, like opening a new location or starting a big renovation.
- Forecasted Ending Cash = Beginning Cash + Projected Incoming Cash – Projected Outgoing Cash
Creating cash flow statements
Now that you know how to calculate cash flow, you’re ready to begin creating cash flow statements. These statements help you see between the data points to reveal trends, give you a better picture of where your finances are or track your income and expenses.
A standard cash flow statement consists of three main components:
1. Operating activities: Cash generated by operating activities (i.e., business as usual)
2. Investing activities: Cash put into investing activities (e.g., purchased assets, sold securities or assets)
3. Financing activities: Cash put into financing activities (e.g., money spent repaying loans, loan interest, creditors, investors or principals)
Each of these details different financial activities within a business that may not be reflected in other reports, such as a profit and loss statement.
Choose what’s best for your business
There isn’t a one-size-fits-all approach to calculating cash flow. It’s up to you to determine which cash flow calculation makes the most sense for your unique needs. Calculating your cash flow is just one of many ways to gauge your business’s financial health. For more info on what else you can do to get a fuller picture of your company’s finances, reach out to a Chase business banker.