Cash Flow: Definition, Types, and How to Calculate

A business’s net cash flow calculates how much cash or cash equivalents are coming in (positive cash flow) or going out (negative cash flow) of the company over a designated period. (Cash equivalents are short-term bonds and other easily liquidated holdings that can turn into cash quickly.)

Cash flow is one of the most important metrics a business owner or potential lender can use when determining a business’s financial health and overall liquidity.

There are three types of cash inflows and cash outflows a business can measure and report:

1. 1. Cash flow from operating (CFO): Also known as the operating cash flow, CFO accounts for the day-to-day cash spent and gained in producing and selling products and services. In other words, it’s the amount of money spent on operating expenses combined with the amount of money brought in by operating activities.
2. 2. Cash flow from investing (CFI): CFI, or investing cash flow, includes the cash balance of a company’s investing activities. CFI can include considerations like interest payments or equity from a business’s property and other assets and capital expenditures like the purchase of new equipment.
3. 3. Cash flow from financing (CFF): Financing cash flow is any cash involved in the funding of the business; it’s money generated from financing activities. Any payments to debtors or investors are part of CFF.

A business’s cash flow gets collected and reported in a cash flow statement that lays out how much cash a business has on hand and from which areas of its business activities. A positive cash flow means that the company can reinvest the cash or pay dividends to shareholders and has enough cash to weather an economic downturn. As a result, it’s a useful data point when considering whether to extend a line of credit or invest in a business.

A negative cash flow could be a bad sign, but you should consider cash flow analysis holistically. Negative cash flow could mean, for example, that the business in question has spent a significant amount on investment or research and development in the given period. Cash flow is one piece of the puzzle alongside the net income recorded in a company’s income statement.

The key difference between cash flow and profit is that cash flow is a measure of real cash coming in and going out of a business. On the other hand, you can record profit for a given period before the cash associated with a transaction changes hands, in a process known as accrual accounting.

For example, suppose a company makes a sale but has not received cash from the customer in the period during which it’s calculating cash flow. In that case, you can include the sale in the profit calculation but not the cash flow calculation. That “cash to be” or future cash flow goes under accounts receivable on a balance sheet.

Similarly, if a company owes money (liabilities) but the repayment hasn’t yet taken place, the money owed would not count against the total cash flow. Instead, you can consider it accounts payable.

You can calculate net cash flow by adding (or subtracting, if they’re negative) the three components of cash flow: CFO +/- CFI +/- CFF. Beyond this simplified formulation, however, there are several ways to determine cash flow. The most important factor in these cash flow calculations is your operating cash flow, as that’s the figure that gives the clearest indication of the core business’s financial health.

• Cash flow from operations: Operating cash flow is the type of calculation a lender would want to see before giving you a loan. This measure from your cash flow statement shows how your cash flow operates regularly. Here’s the formula: Operating income + depreciation - taxes + changes in working capital = operating cash flow.
• Free cash flow: This is the simplest and most common formula to determine cash flow because all of the information required is in other financial statements. First, you need to know the operating cash flow. The second item is the capital expenditures. The equation then looks like this: Operating cash flow - capital expenditures = free cash flow.
• Cash flow forecast: To calculate cash estimates that will come in and go out over a period—your estimated cash position—use this formula: Starting cash + projected cash in - projected cash out = ending cash flow.

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