If you want to create a cash flow statement and understand the financial health of your business, there’s a lot that you need to know. We’re going to outline the multiple formulas that will show you how to calculate free cash flow like a professional.
What is the Cash Flow Formula?
You can generate many different statements for cash flow, but the most important one is a general cash flow formula. The formula will include the following:
- Operating activities, which will include financial activities, payments and the business’s daily expenses.
2. Investing activities, which is cash from your investments.
3. Financing activities, which are capital contributions and money relating to business loans.
A general cash flow formula is cash from operating activities – expenses. However, you can use the data points above to determine cash flow even further.
4. Cash flow = $100,000 (operating activities) +(-) $20,000 (investing activities) +(-) $10.000 (financing activities) + $20,000 (starting cash) = $90,000.
Using A Cash Flow Statement
You’ll find a lot of information on a cash flow statement, whether you receive one from an accountant or generate one using software. The goal is to learn how to use this information to your advantage.
Perhaps you find yourself running close to negative cash flow, so you may decide to take out a loan or apply for a line of credit. You may also look at your investing activities and decide to slow investments until your cash flow is higher.
Cash flow statements provide invaluable insights into the overall health of your business’s operations.
Free Cash Flow Formula
The free cash flow formula shows a business how much cash they have on hand. Cash in this sense is 100% disposable, so it can be used for investments, to save and for future expenses. When you have positive free cash flow, you can capitalize on investments that often lead to the growth of your business.
Free cash flow is: net income + amortization/depreciation – working capital changes – capital expenditures.
And each of these is:
1. Net income will be your profit or loss after accounting for all income coming in and expenses going out.
2. Amortization/depreciation is the reduction of an asset’s value over time and amortization is spreading the cost of the item over its natural use lifetime.
3. Capital expenditures are fixed assets, which include your equipment and land.
4. Working capital is money that you’re already using for your daily business activities.
Putting this all together is easy with a cash flow tool, but let’s look at an example:
Free cash flow for a business with $100,000 in net income, $5,000 in depreciation, $20,000 in working capital changes and $50,000 in capital expenditures would have a free cash flow of $100,000+$5,000-$20,000-$50,000 or $35,000 in free cash flow.
Operating Cash Flow Formula
Operating cash flow (OCF) is the money that you have to cover your business’s operating costs for a certain period of time. When calculating this type of cash flow, it includes unplanned:
- Investments
- Earnings
- Cash flow
You’ll find that this formula is straightforward and easy to calculate, especially if you’ve made it this far in the article and have gone through the other formulas. With operating cash flow, all you need to do is: Subtract taxes from the total of:
- Depreciation
- Working capital changes
- Operating income (earnings before interest and tax)
Considering all of this, your formula would be: OCF = Operating income + depreciation – taxes + working capital changes.
The Importance Of Cash Flow Calculation
Cash flow calculations are crucial to the operation of any business because they can help you:
- Make smarter decisions
- View whether expenses are too high
- Understand where cash is coming in
If you have positive cash flow, your business can continue paying its bills and remain in operation. However, if you have negative cash flow, you can find ways to run a leaner operation or even take out loans or lines of credit to pay your debts on time.
Final Thoughts
Cash flow is an insight into the financial health of your business. Now that you know how to calculate your cash flow properly, let me tell you a secret: it’s easier to automate all of these calculations.
Software and tools reduce errors when calculating cash flow and do it much faster than a person can do it manually.
