Business financing is complex. Your business may be worth a high valuation and have an incredible upward trajectory with great annual revenue, and yet you could easily find yourself lacking the available funds needed to scale, or even to keep day-to-day operations flowing smoothly.
This all comes down to cash flow.
Your cash flow determines how much funding you have available at any point in time. A business with a high valuation, after all, can still struggle with cash flow problems, and many do. Capital can be tied up in unpaid invoices, inventory, advanced-ordered products, and so much more.
Staying on top of your cash flow and knowing exactly what’s available to you should be prioritized when you’re managing the financial side of a business, and knowing how to calculate cash flow in finance is a key part of that.
How to Calculate Your Financial Cash Flow
When calculating your business’s cash flow, there are three different types of cash flow calculations you’ll want to run. Each one gives you different information about your cash flow, including what you have available now for day-to-day operations, what you can afford to reinvest back into the business, and projected availability moving forward.
Three key formulas can help you get a big-picture view of your business’s financial status: Operating cash flow formula, free cash flow formula, and cash flow formula forecast.
The Information You Need to Calculate Cash Flow
For these calculations, you’ll want to have your P&L statements and your balance sheets available.
You’ll also need the following metrics for certain formulas:
- Operating income. This metric subtracts operating expenses (including manufacturing and shipping costs, office maintenance, and employee salaries) from your total revenue.
- Working capital. Subtract your financial liabilities from your financial assets.
- Net income. The business’s total income that remains after business expenses has been subtracted from total revenue.
- Depreciation. This is the measurement detailing how the value of your business assets naturally decreases over time. Equipment, for example, often needs to be replaced over time.
- Amortization. A method used to break down the initial cost of an asset over time.
- Capital expenditure. This shows the financial investments your business makes on fixed assets. These assets typically aren’t easy to liquidate and include equipment, real estate, and land.
1. Operating Cash Flow
It’s crucial for businesses to have a clear and accurate picture of your normal, day-to-day (or month-to-month) cash flow.
There are plenty of tools that show you what your consistent costs and expected profits are, giving you an estimated cash flow that can be useful on its own. These numbers, however, aren’t accurate when you have any irregular spending or earning, including on business-related investments like scaling, training employees, or even obtaining new licensing.
Most lenders will be more interested in your operating cash flow than what you currently have available.
The operating cash flow formula is:
Operating cash flow = Operating Income + Depreciation – Taxes + Changes in Working Capital
2. Free Cash Flow
The free cash flow (FCF) gives you an accurate look into your business’s available funding right now. It will help you determine what cash you have immediately available on hand to use as you see it.
Your FCF is particularly valuable to not only understanding your immediate cash flow but also in making smart financial decisions. If you want to upgrade to a new security system but there’s a large upfront cost, for example, this calculation could help you determine if you’d have the immediate funds available to do so.
This formula considers your overall financial investments, including capital expenditure, net income, and either depreciation or amortization.
The free cash flow formula is:
Free cash flow = Net income + Depreciation/Amortization – Changes in Working Capital – Capital Expenditure
3. Cash Flow Forecast
It’s valuable to have a solid understanding of your immediate cash flow and your typical cash flow over set periods of time, but that’s not all the information you need.
Most businesses try to make decisions that make sense in the present, but that will also benefit them in the future. Financial planning should be taken seriously, and that means accounting for your future projected income, expenses, and overall cash flow.
If you’re able to forecast your cash flow for the upcoming period (which can be a quarter or even a month), you can make smarter decisions now based on what’s projected to be coming soon.
Your cash flow forecast is relatively easy to calculate, and focusing on your projected income and expenses over a set period of time, along with the cash that you expect to have on hand at the beginning of that period. It will give you a rough estimate of how much cash you’ll have leftover.
If you’re unsure of what to expect, look at recent patterns of expenses and income from your business, and look back on past years for seasonal trends that may impact you moving forward. It’s common for jewelry stores, for example, to see significant spikes near Valentine’s Day, Mother’s Day, and the end-of-year holidays.
Here’s how you can calculate your cash flow forecast:
Cash flow forecast = Beginning cash + Projected inflows – Projected outflows
It’s important to remember that the vast majority of small businesses end up closing their doors because of cash flow. With 82% of businesses citing their reason for failure as poor cash flow, this is something you don’t want to overlook.
Have someone in your finance department regularly monitoring your business’s cash flow, including your immediately-available free cash flow and your forecasted cash flow in the future. All three calculations discussed here can help you make informed decisions moving forward so that you can keep your business financially stable.
If you have gaps in your cash flow or if your customers are taking longer to pay, invoice financing could help your company with any working capital needs.