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How to Calculate Cash Flow: 3 cash flow formulas to keep your money moving

Apr 3, 2019 | 5 minutes read | Accounting & taxes

In theory, cash flow isn’t very complicated—it’s a reflection of how money moves into and out of your business. But for most small business owners, the simplicity ends there. Calculating a cash flow formula is different from accounting for income or expenses alone. There’s a lot more to it, and that’s where many entrepreneurs get lost in the weeds.

But for small businesses, in particular, cash flow is also one of the most important ingredients that contributes to your business’ financial health. So much so that one study showed that 30% of businesses fail because the owner runs out of money and 60% of small business owners don’t feel knowledgeable about accounting or finance. After all, when bills come due, you need cash to pay them.

That’s why every business owner needs to develop an understanding of cash flow and what it means for their business. The following three cash flow formulas below make it easier to get that picture of your business financials and better understand how money flows into and out of your business.

1. Free cash flow formula

One of the most common and important cash flow formulas is free cash flow (or FCF).

While a traditional cash flow statement (like the kind you can get from Wave reports) gives you a picture of your business’ 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 cash do you have free 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.

How to calculate free cash flow

Calculating your business’ free cash flow is actually easier than you might think. To start, you’ll need to have your company income statement or balance sheet available to pull key financial numbers from.

First, let’s get the pertinent financial terms straight.

  • Net income: The total income left over after you’ve deduced your business expenses from total revenue or sales. You’ll find this on your Income Statement.
  • Depreciation/Amortization: Many of your business assets (like equipment) lose value over time. Depreciation is the measurement of how that value decreases. Amortization, on the other hand, is a method of breaking down the initial cost of an asset over its lifetime. You’ll find depreciation and amortization on your Income Statement.
  • Working Capital: Working capital is the difference between your assets and liabilities and represents the capital used in the day-to-day operation of your business. You can calculate your working capital using the total assets and liabilities on your Balance Sheet.
  • Capital Expenditure: Capital expenditures include money your business spends on fixed assets, like land, real estate, or equipment. You can find your capital expenditure on the Statement of Cash Flows.

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

Let’s take a look at an example of that 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) to handle client admin tasks is financially feasible.

Her financials for the year look like this:

  • Net income = $80,000
  • Depreciation/Amortization = $0
  • Change in Working Capital = – $10,000
  • Capital Expenditure = $2,500 (Randi bought a new iMac last year)

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.

Looking for more details on Free Cash Flow formula? Read here.

2. Operating cash flow formula

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. That’s because the FCF formula doesn’t account for irregular spending, earning, or investments. 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.

How to calculate operating cash flow:

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:

Operating Cash Flow = Operating Income + Depreciation – Taxes + Change in Working Capital

To apply the OCF formula to our previous example (Randi, our favorite freelance graphic designer), let’s say her financials for the year look like this:

  • Operating Income = $85,000
  • Depreciation = $0
  • Taxes = $9,000
  • Change in Working Capital = – $10,000

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.

Looking for more details on Operating Cash Flow formula? Read here.

3. Cash flow forecast formula

While both FCF and OCF give you a good idea of cash flow in a given period, that isn’t always what you need when it comes to planning for the future. That’s why forecasting your cash flow for the upcoming month or quarter is a good exercise to help you better understand how much cash you’ll have on hand then.

Cash flow problems are never fun (remember they’re responsible for a large majority of small business failures), so it’s important to ensure positive cash flow before you start spending.

How to calculate your cashfFlow forecast:

Your cash flow forecast is actually one of the easiest formulas to calculate. There aren’t any complex financial terms involved—it’s just a simple calculation of the cash you expect to bring in and spend over (typically) the next 30 or 90 days.

The formula looks like this:

Cash Flow Forecast = Beginning Cash + Projected Inflows – Projected Outflows = Ending Cash

Beginning cash is, of course, how much cash your business has on hand today—and you can pull that number right off your Statement of Cash Flows. Project inflows are the cash you expect to receive during the given time period. That includes current invoices that will come due and future invoices you expect to send and receive payment for. Project outflows are the expenses and other payments you’ll make in the given timeframe.

Getting back to our Randi example, let’s say she has:

  • Beginning cash = $30,000
  • Projected inflows for the next 90 days = $30,000
  • Project outflows for the next 90 days = $4,000

Here’s what her cash flow forecast looks like:

[$30,000] + [$30,000] – [$4,000] = $56,000

That means Randi’s forecasted cash flow for the upcoming quarter is $56,000.

Want to create a more detailed cash forecast for the rest of 2019? Check out our article that walks you through the process of creating a comprehensive cash flow projection

Cash flow formulas: Math to keep your cash flowing

As a small business owner, calculating cash flow formulas may not be what gets you fired up—but running out of cash isn’t a problem any business owners wants to face.

Keeping track of cash flow into and out of your business means you have a more holistic understanding of your business’ financial health. You can anticipate cash flow problems and solve them before they hit, and you can optimize your operations so cash flow troubles become a thing of the past.

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