Net Cash Flow and How It’s Used
Last Updated November 20, 2024
If you’re a first-time small business owner, you’re probably getting hit with financial terms like “net cash flow” that would make the average person want to run for the hills. However, it is important to stay informed to help your business remain afloat. Understanding bankruptcy, profit and loss and everything in between – financial literacy is the key to keeping the doors open.
Net cash flow is one of those many terms you’ll become familiar with as you begin your small business journey. So, while you’re sitting there trying to get your business’s financial house in order, let’s talk about the importance of net cash flow and how you’ll use it.
What Is Net Cash Flow?
Even if you’ve never taken a business course or gotten acquainted with your accountant, calculating your net cash flow is going to let you know if your business is on the right track.
Net cash flow is a simple way to measure if your business is profitable. Want to know if last month was a good month or a bad one? Net cash flow is going to help you answer the question.
How to Find Net Cash Flow
Grab a sticky note and write this net cash flow formula down:
Total Cash Inflows – Total Cash Outflows = Net Cash Flow
We’ll go further in-depth shortly, but let’s nail down the foundation of this business calculation. A cash inflow is money you have coming into your business – whether that be from sales, financing, or investments. A cash outflow is money coming out as operating expenses like rent, equipment, and salaries to your employees.
Doing this calculation, even on a napkin or in the Calculator app on your phone, will give you an idea of your business’s health. If your net cash flow is positive over several months, then your business is in fantastic shape. A negative net cash flow is a sign that things are not going well.
Net Cash Flow Formula (With Example)
Let’s break it down further and bring some math into this equation. Say your business took in $10,000 last month in cash inflows. Your business disbursed $8,000 in cash outflows. Using the formula above, we’ll see the company operated with a positive net cash flow of $2,000 last month.
$10,000 (total cash inflow) – $8,000 (total cash outflow) = $2,000 (net cash flow)
Conversely, let’s say last month your business took in $8,000 and disbursed $10,000. With our net cash flow formula, you’ll see that we’re dealing with a negative net cash flow of $2,000.
$8,000 (total cash inflow) – $10,000 (total cash outflow) = -$2,000 (net cash flow)
Now that we’ve got the basics covered, we can move on to a more in-depth way to calculate net cash flow.
Breaking Down Your Net Cash Flow Calculation Even Further
We touched on the idea earlier that net cash flow can be a simple equation. But there is an even more detailed equation that breaks your business’s net cash flow to an even more specific figure. Our friends at Wave Accounting have the breakdown.
Operating Activity Cash Flow + Investment Activity Cash Flow + Financing Activity Cash Flow = Net Cash Flow
That can be intimidating to look at if you’ve never seen those terms before. That’s why you’re reaching out for help, though. To get us on track to understanding these new terms, we’ll explain metric by metric.
Operating Activity Cash Flow, or CFO, is the money your business brings in from typical business activities like sales of goods or services. The CFO also includes operating expenses like employee salaries, rent, or website hosting, to name a few.
Investment Activity Cash Flow, or CFI, is the money gained or lost from business investments. These might be things like assets or stock purchases. It can also be investments in the business itself, such as property, equipment, or research and development.
Financing Activity Cash Flow, or CFF, is a type of funding generated by a business. For example, a business can issue equity or debt to raise the funding necessary to invest further into the company.
With all those financial terms out of the way, we can put some numbers to help bring this into focus.
- Last month, your business had $10,000 as CFO.
- Of that, $12,000 came in and $2,000 went out.
- Your CFI was -$1,000 because $4,000 came in but $5,000 went out.
- Finally, your CFF was $15,000 after $20,000 came in and $5,000 went out.
Using our formula above, we’ll plug in our numbers:
$10,000 (CFO) + -$1,000 (CFI) + $15,000 (CFF) = $24,000
A positive net cash flow of $24,000 last month is acceptable in this case. However, that would be a different story if this number came back negative.
Benefits and Limitations of Net Cash Flow
Knowing that a simple equation can tell you plenty about the health of your business can put many people at ease.
Understanding this calculation allows you to control the business finances better to mitigate the risks when you grow your enterprise. Being able to track your net cash flow each month, quarter, and year will give you greater insight in your company’s financial health and allow you to stay on top of your expenses.
However, net cash flow can also have its limitations. Reducing a company’s health down to a single metric rarely tells the full story. Having a full-scale accounting system in place is the only way to ensure that your net cash flow is calculated accurately.
Net Cash Flow vs. Free Cash Flow: What’s the Difference?
Free cash flow is yet another metric that can show if your business is profiting. While you calculate the generated net cash flow by adding CFO, CFI, and CFF, you calculate free cash flow by subtracting CFO from capital expenditures, according to Investopedia.
Capital expenditures may include buying a new building or renovating the one you’re currently using. Back to that sticky note from earlier – let’s make one more addition:
CFO – Capital Expenditures = Free Cash Flow
Financial analysts and other business types often use free cash flow to help measure a business’s value.
A sound accounting system is the best way to know the financial health of your business. With all these business accounting terms a little more demystified, you can now understand what it takes to keep a business going.
In-Summary: Net Cash Flow
Net cash flow is one of many metrics you can use to measure business performance.
According to altLINE CEO Gates Little, it’s something every business owner should regularly calculate and monitor.
“At minimum, you should be calculating net cash flow on a monthly basis,” Little said. “Doing so allows you to identify room for growth, or on the other hand, potentially concerning trends before they fully impact your business.”
For example, you might find that your operating activity cash flow is overwhelmingly positive, meaning you might be able to afford to bring on a new full-time employee. Or you might find that your cash flow is being held back by slow-paying customers, prompting you to find a solution quickly.
“It can be hard at first to consistently make time in your schedule to track important business KPIs like this rather than devoting all your efforts toward driving sales, but it will pay off in the long run,” Little added. “It can be the key to building a successful business.”
Grey was previously the Director of Marketing for altLINE by The Southern Bank. With 10 years’ experience in digital marketing, content creation and small business operations, he helped businesses find the information they needed to make informed decisions about invoice factoring and A/R financing.
