In theory, cash flow isn’t too complicated. Simply put, cash flow is a reflection of how money moves into and out of your business.
Unfortunately, for small business owners, both understanding and using cash flow formulas doesn’t always come naturally. In fact, 60% of small business owners say they don’t feel knowledgeable about accounting or finances.
But we can change that—starting here.
First, let’s talk about the importance of cash flow. For small businesses in particular, cash flow is one of the most critical ingredients in their financial health. One study showed that 30% of businesses fail because they run out of money.
Using cash flow formulas can help you prepare for slow seasons and ensure you have enough money on hand before spending on your business.
Here’s what we’ll cover in this article to help you calculate cash flow like a pro:
1. Important cash flow formulas, including:
2. Why calculating cash flow is important
The following cash flow formulas each have their own benefits and tell you different things about your business.
Let’s go over definitions, calculations, and examples together. To make things extra easy, you can use our free cash flow calculator to follow along.
One of the most common and important cash flow formulas is free cash flow (FCF).
While a traditional cash flow statement (like the kind you can generate with Wave) gives you a picture of your business’s cash at a given time, that doesn’t always help with planning and budgeting—because it doesn’t truly reflect the cash you have available, or that’s free to use.While a traditional cash flow statement (like the kind you can get from Wave reports) gives you a picture of your business’s cash at a given time, that doesn’t always help with planning and budgeting—because it doesn’t truly reflect the cash you have available, or free to use.
Can you afford to invest in that new software? Do you have enough cash on hand to pay for that virtual assistant when their invoice comes due? How much money do you have available to spend on thank you cards for your clients?
Calculating the cash you have available to spend (via the FCF formula) helps answer those questions and others like them.
Calculating your business’s free cash flow is actually easier than you might think. To start, you’ll need your company income statement or balance sheet to pull key financial numbers.
First, let’s get some important financial terms straight.
With that knowledge in hand, the basic formula for free cash flow looks like this:
Free cash flow = Net income + Depreciation/amortization – Change in working capital – Capital expenditure
The free cash flow formula is suited for any business owner who wants to get the most accurate look at their financial health. And this could be for many reasons. For example:
Free cash flow formula tells you the difference between cash generated from standard business operations and cash spent on assets. Ultimately, it indicates your business’s financial performance and health, and ability to stay in business.
Let’s take a look at an example of this formula in the real world. Randi’s a freelance graphic designer—she needs to calculate her free cash flow to see if hiring a virtual assistant for 10 hours a month is financially feasible.
Her financials for the year look like this:
So Randi’s free cash flow is represented by:
[$80,000] + [$0] – [-$10,000] – [$2,500] = $67,500
That means she has $67,500 in available cash to reinvest back into her business.
Net cash flow formula is one that’s regularly used by business owners.
This formula gives you the difference between the money coming in and the money coming out of your business for a specific period.
Here’s how it works:
Easy, right? Now let’s review the business activities that net cash flow comes from.
To calculate net cash flow, you’ll have to find the difference between the cash inflow and the cash outflow. There are a few ways to calculate net cash flow, but let’s start with the basics of the net cash flow formula:
If you want to go a step further, you can separate cash flow by category: operating, financial, and investment..
Let’s use the example of Shania, who runs a small-but-mighty indie magazine. To find out her net cash flow for the quarter, she’ll look at the following:
Cash flow from operating activities
Cash flow from investment activities
Cash flow from financial activities
To calculate net cash flow, we’ll use the following math:
The key about net cash flow is that it can fluctuate. For instance, investments or your operating costs may change over time. In the case of Shania and her magazine, she might decide to move from print to digital, drastically reducing operational costs. However, this shift might also reduce sponsorship, changing her cash flow in other areas.
With that in mind, remember to look at the context behind the numbers, not just the numbers themselves. This can give you a more realistic view of your net cash flow and the health of your business.
Knowing your cash flow from your operations is a must when getting an accurate overview of your cash flow.
While free cash flow gives you a good idea of the cash available to reinvest in the business, it doesn’t always show the most accurate picture of your normal, everyday cash flow. Here’s why: the FCF formula we mentioned above doesn’t account for irregular spending, earning, or investments. So, if you sell off a large asset, your free cash flow would go way up—but that doesn’t reflect typical cash flow for your business.
When you need a better idea of typical cash flow for your business, you want to use the operating cash flow (OCF) formula.
For example, if you’re looking to secure outside funding from a bank or venture capital firm, they’re more likely to be interested in your operating cash flow. The same goes if you begin working with an accountant or financial consultant, so it’s important to understand what OCF looks like for you before seeking funding.
Just as with our free cash flow calculation above, you’ll want to have your balance sheet and income statement at the ready, so you can pull the numbers involved in the operating cash flow formula.
There’s one other financial metric you’ll need to know for this calculation: Operating income.
Also called “earnings before interest and taxes” (or EBIT) and profit, your operating income subtracts operating expenses (like wages paid and cost of goods sold) from total revenue. You can find operating income on your income statement.
The basic OCF formula is:
To apply the cash flow from operations formula to our previous example (Randi, our favorite freelance graphic designer), let’s say her financials for the year look like this:
Randi’s operating cash flow formula is represented by:
[$85,000] + [$0] – [$9,000] + [-$10,000] = $66,000
That means, in a typical year, Randi generates $66,000 in positive cash flow from her typical operating activities.
