How to Calculate Cash Flow
Cash flow represents the net amount of cash and cash equivalents being transferred into and out of a business. It’s a vital metric to assess a company’s liquidity, flexibility, and overall financial performance.
Cash flow can be calculated for several financial categories: operating, investing, and financing activities. These are often summed up in a cash flow statement, one of the major financial statements provided by companies.
- Operating Cash Flow: It represents the cash generated from the core business operations of the company. It’s calculated as follows:
Operating Cash Flow = Net Income + Non-Cash Expenses (such as depreciation and amortization) + Changes in Working Capital
Where “Changes in Working Capital” is basically changes in current assets (like inventory, accounts receivable) minus changes in current liabilities (like accounts payable, accrued expenses). - Investing Cash Flow: This involves the cash used for investing in the business, like buying property or equipment or cash earned from selling investments like divesting from a business or selling a piece of equipment.
- Financing Cash Flow: This involves the cash that is generated or spent on financing activities, like issuing and repaying debt and equity, as well as paying dividends.
Total Cash Flow for a certain period (usually a year or a quarter) can then be calculated by summing up the cash flows from all three activities:
Total Cash Flow = Operating Cash Flow + Investing Cash Flow + Financing Cash Flow
Positive cash flow indicates that a company’s liquid assets are increasing, enabling it to settle debts, reinvest in its business, return money to shareholders, pay expenses, and provide a buffer against future financial challenges. Negative cash flow indicates that a company’s liquid assets are decreasing.
It’s important to note that having negative cash flow isn’t always bad. It can just indicate that the company is investing heavily in its future growth.
Example of How to Calculate Cash Flow
Let’s consider a hypothetical example using simplified figures to calculate cash flow:
Let’s say that for the year 2022, a company called ABC Corp has reported the following:
- Net Income: $500,000
- Depreciation & Amortization: $100,000
- Increase in Accounts Receivable: $50,000
- Increase in Inventory: $20,000
- Increase in Accounts Payable: $30,000
- Investments in Property, Plant & Equipment: $200,000
- Proceeds from Sale of Investments: $150,000
- Issued New Debt: $300,000
- Repaid Debt: $100,000
- Paid Dividends: $50,000
First, calculate the Operating Cash Flow:
Operating Cash Flow = Net Income + Non-Cash Expenses + Changes in Working Capital
= $500,000 + $100,000 + [($30,000) – ($50,000 + $20,000)]
= $600,000 – $40,000
= $560,000
Next, calculate the Investing Cash Flow:
Investing Cash Flow = Proceeds from Sale of Investments – Investments in Property, Plant & Equipment
= $150,000 – $200,000
= -$50,000
Next, calculate the Financing Cash Flow:
Financing Cash Flow = Issued New Debt – Repaid Debt – Paid Dividends
= $300,000 – $100,000 – $50,000
= $150,000
Finally, calculate the Total Cash Flow:
Total Cash Flow = Operating Cash Flow + Investing Cash Flow + Financing Cash Flow
= $560,000 – $50,000 + $150,000
= $660,000
So, for the year 2022, ABC Corp has a total cash flow of $660,000.
Please remember that this is a very simplified example. In practice, there could be many more components to consider within operating, investing, and financing cash flows.
