As a small business owner, understanding and using cash flow formulas might be a foreign language. According to recent studies, around 60% of small business owners have admitted they don't feel knowledgeable about accounting or finance. Are you trying to learn more about cash flows from the very beginning?
Three fundamental cash flow formulas will help you understand cash flow better: free cash flow, cash flow from operations, and cash flow forecast. In this article, we will teach you how to calculate your cash flow using these formulas with examples, so you can feel more confident about your finances and controlling your business' financial health.
Types of cash flow
Let's begin with the three types of cash flow that your business can have: cash flow from operations, cash flow from investing, and cash flows from financing.
Cash flow from operations
Cash flow from operations (CFO), or operating cash flow, represents the financial transactions directly related to manufacturing and selling items in everyday business operations. A company's CFO can tell whether or not it has enough money to cover its bills or operational costs. In other words, for a business to be financially viable over the long run, there must be more operating cash inflows than operating cash outflows.
Cash from sales is subtracted from cash paid for operational expenses to determine operating cash flow. Operating cash flow has to be noted on your company's cash flow statement, which is presented both quarterly and annually. Operating cash flow shows if a business can produce enough cash flow to support and grow its operations, but it can also show when a company could need outside finance for capital growth.
Cash flow from investing
The term "cash flow from investing" (CFI) or "investing cash flow" is the report that shows how much money was made or spent within a given period on any investment-related activities. Buying speculative assets, investing in securities, or selling securities or assets are all examples of investing activity.
It's important to mention that if this type of cash flow is negative, that is not always a warning indicator and could result from considerable sums of money spent on the long-term success of the business, such as for research and development.
Cash flow from financing
Lastly, "financing cash flow," also known as "cash flows from financing," refers to the net cash flows utilized to finance a company's capital. These include transactions such as issuing debt, equity, and dividend payments. Investors can learn about the financial health and management of a company's capital structure from the cash flow from financing activities.
Important cash flow formulas to know about
These three cash flow formulas have advantages and can provide specific information about your company.
First, let's remind you of a few essential terms for the following formulas:
Net income: Is the total income left over after you've deduced your business expenses from total revenue or sales.
Depreciation/amortization: The value lost from certain assets over time. Depreciation is the measurement of how that value decreases. Amortization breaks down the initial cost of an asset over its lifetime.
Working capital: Is the difference between your assets and liabilities, representing the capital used in the day-to-day operations.
Capital expenditure: This includes the money your business spends on fixed assets, such as land, real estate, or equipment.
Operating income: Also known as Earnings Before Interest and Taxes and profit. The operating income subtracts operating expenses (like wages paid and other costs) from total revenue.
Beginning cash: How much cash your business has in hand today.
Project inflows: The cash you expect to receive during a specific period.
Project outflows: The payments and expenses you'll have during that time frame.
1. Free cash flow formula
Free Cash Flow = Net income + Depreciation/Amortization – Change in Working Capital – Capital Expenditure.
This is a very common formula to use. Why? Because this one helps you calculate the amount of money you have available. With it, you can evaluate if you can buy a new piece of software, have new staff joining the business, or even market. The numbers you need to do this formula can be found in your company Income Statement or Balance Sheet. Let's look at an example of how this formula looks in practice:
Free cash flow formula example:
Let's assume you have a small photography business, and these are your numbers:
Net income = $50,000
Depreciation/Amortization = $0
Change in Working Capital = – $8,000
Capital Expenditure = $1,800 (you just bought a new camera)
Your free cash flow is represented by:
[$50,000] + [$0] – [-$8,000] – [$1,800] = $40,200
That means you have $40,200 in available cash to reinvest into your company.
2. Operating cash flow formula
Operating Cash Flow = Operating Income + Depreciation – Taxes + Change in Working Capital
With this formula, you can understand the overview of the cash flow of your business because it counts for your irregular spending, earnings, or investments. If you want to secure more funding from a venture capital firm, they will want to know your operating cash flow. Let's take a look at an example of what this looks like:
Operating cash flow formula example:
Let's keep going with your photography business! Say this is how your financials look like this year:
Operating Income = $55,000
Depreciation = $0
Taxes = $10,000
Change in Working Capital = – $8,000
Your operating cash flow formula is represented by:
[$55,000] + [$0] – [$10,000] + [-$8,000] = $37,000
That means that in a typical year, your photography business generates $37,000 in positive cash flow from your regular operating activities.
3. Cash flow forecast formula
Cash Flow Forecast = beginning Cash + Projected Inflows – Projected Outflows = Ending cash.
This formula is the best one to understand how to plan for the future. Forecasting your cash flow for the upcoming month or quarter is a good exercise in understanding what you'll need and what you might have in hand for the future, so you know if you can think of those projections.
Going back to our photography business example, let's say you have:
Beginning cash = $40,000
Projected inflows for the next 90 days = 40,000
Project outflows for the next 90 days = $5,000
Here’s what your cash flow forecast would look like:
[$40,000] + [$40,000] – [$5,000] = $75,000
That would mean your forecasted cash flow for the upcoming quarter is 75,000.
Grow your business' cash flow with us
Now that you know how to calculate different types of your cash flow start projecting for your growth!
With One Park Financial, you can focus on the future without worrying about anything else. We work to help owners of small and mid-sized businesses access the working capital they need to grow like never before. Our process is simple, and we've helped many small businesses who have been turned down by banks to access funding. Apply now and get verified in minutes!
Disclaimer: The content of this article is based on the author’s opinions and recommendations alone. This material has been prepared for informational purposes only. It is not intended to provide and should not be relied on for tax, legal, or accounting advice. We suggest consulting with your tax, legal, and accounting advisor before engaging in any transaction.