How to Calculate Cash Flow

Navigating the Cash Flow Landscape: 3 Types of Cash Flow

Not all cash flows are created equal. Here are the three main categories of cash flow on the Statement of Cash Flow that you need to understand:

1. Operating Cash Flow: This measures the cash generated by your core business activities, including sales, operating expenses, and inventory changes. It’s your bread and butter, the lifeblood that keeps your day-to-day operations running smoothly. This is the easiest type to understand as it closely resembles the income statement.

2. Investing Cash Flow: This reflects the cash movement associated with your investments, such as purchasing new equipment, acquiring other businesses, or investing in financial instruments. It represents your growth and expansion potential.

3. Financing Cash Flow: This tracks the cash you receive or pay from lenders and investors. Think of it as the oxygen that fuels your expansion, but be mindful of overdependence, as excessive debt can be a burden.

Formula Focus: Calculating Operating Cash Flow Step-by-Step

Ready to roll up your sleeves and get down to the nitty-gritty? Here’s how to calculate your operating cash flow, the most crucial of the bunch:

1. Gather Your Tools: You’ll need your income statement (profit and loss statement) and balance sheet. These financial documents provide the raw data for your calculations.

2. Start with Net Income: Locate your net income on the income statement. This is your starting point, the profit your business generates through its operations.

3. Adjust for Non-Cash Expenses: Depreciation and amortization are expenses that don’t involve actual cash outflow. Add them back to your net income to get a more accurate picture of your cash flow.

4. Manage Working Capital Changes: Track the change in your current assets and liabilities (inventory, accounts receivable, accounts payable) between two periods. An increase in liabilities or decrease in assets represents a cash inflow, while the opposite indicates a cash outflow. Factor this change into your calculations.

5. Tally the Tolls: Add up all your operating expenses, including rent, salaries, utilities, and other cash outflows.

6. Unveiling the Truth: The grand finale! Subtract your total operating expenses and working capital changes from the adjusted net income. The resulting figure? Your glorious operating cash flow!

Example Time: Putting Theory into Practice

Let’s say your company, “Acme Widgets,” had a net income of $10,000 last month. You also had $2,000 of depreciation and an increase in accounts payable of $1,500. On the other hand, your operating expenses totaled $8,000. Plugging these figures into our formula, we get:

Operating Cash Flow = $10,000 (Net Income) + $2,000 (Depreciation) + $1,500 (Change in Accounts Payable) – $8,000 (Operating Expenses)

Operating Cash Flow = $5,500

Congratulations, Acme Widgets! You have a positive operating cash flow of $5,500. This means your business is generating enough cash to cover its expenses and even have some left over for reinvestment or debt repayment.

Although you may not need to look at the detail of your Operating Cash Flow movement or the other two categories, you should always have a good read on the bottom of the Statement of Cash Flow that shows your net cash movement for the period.