Businesses can either thrive or deteriorate depending on their cash flows. When a company brings in more cash than it spends, it enjoys a positive cash flow, which often corresponds with a sustained, profitable existence. But when cash flows in the opposite direction—when more money leaves the company than comes in—financial performance suffers and the company risks insolvency.
To assess cash flow, accountants and business owners use cash flow formulas that combine a company’s cash inflow with its cash outflow.
What is a cash flow formula?
A cash flow formula is a financial equation that accountants and business owners use to calculate the net income of a business. Cash flow statements can reflect different types of financial transactions. Some limit themselves to core business activities, like manufacturing and sales, while others include ancillary income, like dividends from investments. Analysts and investors study these various cash flow statements to gauge a company’s financial health.
4 key cash flow categories
A cash flow analysis looks at the money entering and exiting an organization. But there’s more than one way to track cash flow. Some cash flow analyses matter more to a company’s operations managers, while others are more relevant to outside investors. Depending on your specific accounting goals, you may find yourself working with one or more of the following cash flow categories:
- Net cash flow. Net cash flow is the change in a company’s cash, or cash equivalents, within an accounting period. You generally determine net cash flow by subtracting all monetary expenditures from all income.
- Operating cash flow. An operating cash flow analysis reveals whether your company is making a net profit from its core business operations. It specifically looks at monetary inflows and outflows from a company’s core work—like manufacturing or sales—and leaves out cash flows related to outside investing or non-core operations.
- Free cash flow. Free cash flow reveals the total amount of money available after a company has fulfilled its capital expenditures, dividend payments, and debt servicing obligations. Free cash can be spent on day-to-day operations, used for new business investments, or distributed to shareholders.
- Discounted cash flow. A company conducts a discounted cash flow analysis to weigh the value of an investment. This analysis determines an investment’s net present value (NPV)—essentially, its estimated future value minus its current asking price.
How to calculate cash flows
Cash flow formulas run the gamut from simple to complex. Most contemporary businesses use accounting software to tabulate cash flow. Still, it helps to understand the underlying inputs. Here are four main formulas used to calculate cash flow.
Net cash flow formula
Your net cash flow combines component cash flows from different parts of your business. All formulas that track net cash flow subtract a company’s expenses from its cash on hand, giving you the net cash balance for the accounting period in question. To determine your company’s net cash flow, use the following formula:
Each of these inputs—initial cash, operations cash, investing cash, and financing cash—can be either positive or negative. For instance, it’s common for a startup company to have negative cash flows from operations, but positive cash flows from financing activities (in the form of investment capital). Years later, that same company may have positive cash flows from operations but could have negative cash flows from financing because it’s actively repaying lenders.
Operating cash flow formula
To calculate your company’s operating cash flow, start by adding its operating income from sales (i.e., its earnings before interest and taxes) with its non-cash expenses (like depreciation of fixed assets, issued stock, and deferred taxes). From this amount, subtract outflows from operating expenses, including salaries, vendor fees, lease payments, taxes, and interest payments, as well as changes in working capital (the difference between a company’s current assets and liabilities). The operating cash flow formula is, therefore:
Operating cash flow = operating income + non-cash expenses – taxes + changes in working capital
Free cash flow formula
Calculating free cash flow reveals how much your company must spend on day-to-day operations. To determine your free cash flow, subtract the cost of your company’s capital expenditures within the accounting period (including property, plant, and equipment expenses and debt servicing) from its net operating profit after taxes (including net income, depreciation, amortization, and working capital). Here’s what the formula looks like:
Discounted cash flow formula
The discounted cash flow formula is more complex than an operating or free cash flow formula. At its core, it uses projected inflows of income and projected outflows of expenses to determine the asset’s net present value. The discounted cash flow formula is:
It uses the following inputs:
- CF1: Cash flow for Year 1
- CF2: Cash flow for Year 2
- n: A future period measured in years
- CFn: Cash flow for future years
- r: Discount rate or internal rate of return (IRR)
The ellipse in the formula (...) indicates that you add new inputs for every year until you reach n years in the future, where n is a variable of your choice. Investors use this formula to forecast a company’s net income and cash balances many years into the future. This helps them decide if a company is worthy of investment. It can also help lenders determine whether extending business loans to a company is safe. If the lender foresees many years of negative cash flow, it may choose not to lend.
Cash flow formula FAQ
How do you calculate cash flow from a balance sheet?
A balance sheet contains many more elements than a cash flow statement. These elements include assets (like accounts receivable, inventory, and fixed assets), and liabilities (like accounts payable, shareholder equity, provisions, and financial debt). If you want to calculate net cash flow from these entries, use the following formula: Net cash flow = Δ equity + Δ financial debt + Δ payables + Δ provisions – Δ fixed assets – Δ receivables – Δ inventory (where Δ is the mathematical symbol for “change in”) Note that this is a relatively indirect way of determining cash flow. You usually calculate a company’s cash flow by adding up the cash (and cash equivalents) coming in and subtracting the total of cash (and cash equivalents) going out.
What are 3 types of cash flows?
Operating cash flow, which measures the cash flow generated by day-to-day operations Free cash flow, which measures cash on hand after capital expenditures Discounted cash flow, which investors use to find the net present value of a company at the time of investment
What is an example of cash flow?
To see a cash flow formula in action, imagine a restaurant’s operating cash flow. The restaurant has an operating income of $20,000. Its non-cash expenses include depreciation of its ovens, which have lost $1,500 in value. It pays $4,000 in taxes. Its working capital—the amount it spends running the business—decreases by $6,000. The formula for operating cash flow is: Operating cash flow = operating income + non-cash expenses – taxes + changes in working capital The restaurant’s operating cash flow therefore equals $20,000 + $1,500 – $4,000 – $6,000, giving it a positive operating cash flow of $11,500.