How much money does your company have? Maybe this question makes you fumble and squirm a bit, but knowing how much money your business has passing through it is central to knowing how well your business is performing. One way to understand the financial health of your company is to calculate your net cash flow.
What is net cash flow?
Net cash flow is the money your business has left after you’ve paid off all your operating costs and made your debt payments. Or, in accounting terms, it’s the difference between your company’s cash inflows and cash outflows over a given period. You report your net cash flow in a cash flow statement, which—along with an income statement and balance sheet—is one of the three fundamental financial statements that indicate your company’s financial health.
How do you calculate net cash flow?
The net cash flow formula is simple: Take your company’s total cash inflows and subtract its total cash outflows. If the result is positive, your company has more money coming in than going out for the period in question. If the result is negative, there’s more cash leaving than coming in.
There are three types of net cash flow activities that contribute to your company’s total net cash flow:
- Operating activities. Operating activities refer to the money your business makes and loses through products or services you sell. It includes cash receipts from your customers, the money you spend to produce the products or services you sell, and your administrative expenses.
- Financing activities. Financing activities refer to the cash generated through debt agreements. It’s the money used to pay off existing debt, repurchase company shares, or pay out dividends (negative transactions), or the money gained through new loans or selling company shares (positive transactions).
- Investing activities. Investing activities refer to money you’ve made from investments or cash spent on purchasing a buy or a fixed asset.
Formula for net cash flow
You can calculate the net cash flow for each of the above activities using the following formula:
Net Cash Flow = Total Cash Inflows - Total Cash Outflows
Then, to calculate your business’s net cash flow, add up the net cash flow of each activity. In other words:
Net Cash Flow = Net Cash Flow from Operating Activities + Net Cash Flow from
Financing Activities + Net Cash Flow from Investing Activities
For example, let’s say Dwight’s Beetroot Ice Cream Shoppe has a net cash flow of $25,000 from its operating activities. Still, his net cash flow from investing activities is -$70,000 because Dwight purchased a small storefront to expand his business this year. Luckily, his net cash flow for financing activities is $90,000 because his cousin Mose paid back some money he owed. To calculate Dwight’s net cash flow, you would therefore use the following equation:
$25,000 + $90,000 - $70,000 = $45,000
The result shows that Dwight’s Beetroot Ice Cream Shoppe has a positive cash flow and is in a good financial position this year. Had the result been a negative number, the Shoppe would have had a negative net cash flow, signifying a weaker financial standing.
Advantages of knowing your business’s net cash flow
- See trends
- Forecast growth
- Attract investment
- Locate weaknesses
Knowing your company’s net cash flow is essential to growing your business—or future-proofing it. Here are reasons you might want to keep track of your net cash flow:
- See trends. Calculating your net cash flow consistently over an extended period can give you an idea of how much money you have coming in and going out on a regular basis. This can help you budget and allow you to make necessary adjustments to keep your business afloat.
- Forecast growth. Net cash flow can be used as a predictor of future success. If you're bringing in more money than you’re spending, it’s a sign your business is growing and will likely expand over time.
- Attract investment. Net cash flow helps investors decide whether they want to invest in your business. Potential investors want to know if your business has enough cash to cover its expenses. If not, they might want to reconsider. Likewise, if your company has shareholders, it’ll want to monitor its net cash flow to make sure that it’s in good financial health.
- Locate weaknesses. Net cash flow can help you identify potential problems early on so you can take corrective action before it’s too late. Understanding and tracking your net cash flow allows you to put your business on the path to long-term success.
Net cash flow FAQ
What is the difference between cash flow and net cash flow?
Net cash flow is a company’s total cash inflow and total cash outflows. A company’s cash flow includes all aspects of its financial health, including operating activities, investing activities, and financing activities.
What is the net cash formula?
The net cash flow formula is: Net Cash Flow = Cash Inflows – Cash Outflows
What is considered a healthy cash flow?
A company with a healthy cash flow can typically make its loan payments, pay its bills, and have money left over to reinvest in the business. A healthy cash flow is usually indicative of a well-run business.
What are the limitations of net cash flow?
Net cash flow may not provide a complete picture of a company's financial health. While it’s a helpful metric, it has several limitations that should be considered when interpreting the data:
- Net cash flow does not consider the timing of cash inflows and outflows, making it difficult to compare companies with different fiscal years or accounting periods.
- A positive net cash flow may result from a loan’s cash payments, which means it also reflects a debt. Similarly, a negative cash flow could reflect investments that are expected to pay off in the future.
Despite these limitations, net cash flow remains a valuable metric for assessing a company's financial health. When used in conjunction with other financial measures, it can provide crucial insight into your business’s overall financial performance.