If there’s one calculation you should regularly use, it’s the net cash flow formula. Knowing your cash flow (the movement of money in and out of your business) can be the difference between making a profit and going out of business (...eep!).
Below, we’ll look at the definition and formula for net cash flow, and why you need it.
What is net cash flow?
Net cash flow is the difference between the money coming in and the money coming out of your business for a specific period. When you’re making money, your net cash flow will be positive. But when you’re in the negatives, that means your business is losing money. Cash inflow refers to what comes in, and cash outflow is what goes out.
Net cash flow comes from three business activities:
- Operating: Cash generated and spent by a company to be able to run standard business operations. This includes cash payments from customers, cost of goods sold, administrative expenses, and marketing.
- Financing: Financing cash outflow and inflow includes debt and dividend payments, company shares, and small business loans, among others.
- Investment: This includes when businesses earn or pay interest on investments or purchase a business investment like equipment or property.
You can look at net cash flow both for an isolated period of time and comparatively, period over period. It’s important to do both. The former will show you the likelihood of your business continuing in the short-term, while the latter will give you a bigger picture idea of trends over time—and, more importantly, long-term viability.
What is the net cash flow formula?
To calculate net cash flow, you need to find the difference between the cash inflow and the cash outflow. The basic net cash flow formula is straightforward and easy to use:
Net cash flow = cash receipts - cash payments
But you can also separate cash flow by category: operating, financial, and investment. To calculate net cash flow this way, you’ll use the following formula:
Net cash flow = operating activity cash flow (CFO) + investment activity cash flow (CFI) + financing activity cash flow (CFF)
To get CFO, CFI, and CFF, you’ll look at your cash inflow and outflow. Cash inflow might include:
- Customer payments
- Sale of goods or services
- Loan receipts
- Cash dividends
- Interest earned
- Fixed asset sales
- Supplier and vendor refunds
- Grants
- Third-party funding
- Lawsuit settlements
- Insurance claims
- Equipment sales
- Property sales
- Any form of cash received
While cash outflow can include:
- Payroll
- Supplier and vendor payments
- Taxes
- Fees
- Fines
- Licenses
- Interest paid
- Fuel and transportation costs
- Rent
- Utilities
- Marketing and advertising spend
- Debt payments
- Equity investment
- Buy back stocks
- Shareholder payout
- Property purchase
You can also use your balance sheet to calculate net cash flow. It’s easy, simply look at the cash balance for two different periods and calculate the difference… See, even your fourth grade math teacher would be proud!
Net cash flow example
Now that we have the net cash flow formula handy, let’s put it into practice. For this example, let’s say you own a pet salon. Your cash flow for the month of January breaks down like this:
Cash flow from operating activities
- $50,000 came in
- $10,000 went out
Cash flow from investment activities
- $2,000 came in
- $4,000 went out
Cash flow from financial activities
- $10,000 came in
- $5,000 went out
Now, let’s calculate net cash flow:
Net cash flow = CFO + CFI + CFF
Net cash flow = ($50,000 - $10,000) + ($2,000 - $4,000) + ($10,000 - $5,000)
Net cash flow = $40,000 + -$2,000 + $5,000
Net cash flow = $43,000
Your investments didn’t do so well, but the CFO and CFF balance it out and bring you to a positive net cash flow (yay!).
Over time, you track your net cash flow each month. It looks like this for the first six months of the year:
January: $43,000
February: $45,000
March: $50,000
April: $30,000
May: $35,000
June: $36,000
Everything looks pretty normal, until we get to April. This dip in net cash flow needs further investigation.
Let’s say you moved locations in April to expand your pet salon. This new location also has higher rent and utilities. These increased operating costs will naturally lower your net cash flow. So while the decline isn’t cause for alarm, you want to make sure you continue to trend upward—otherwise this move wasn’t a profitable one.
There are so many scenarios that can cause fluctuations in net cash flow. It’s important to look at the bigger picture and consider the context in addition to the actual metrics when you calculate net cash flow.
Why is net cash flow important?
Now that we’ve gotten into the nitty-gritty, let’s jump into what the point of net cash flow actually is (what, you don’t love doing math for fun?!). The net cash flow formula shows you how much capital you have on hand to continue operating your business. Cash is important for day-to-day operations—you often need it to pay bills, vendors, insurance, and other necessary operating expenses.
If you run out of cash flow, you run the risk of not being able to keep the lights on, both literally and figuratively speaking. That’s why it’s important to track whether your cash flow is positive or negative.
Positive cash flow
When you see positive cash flow, that means more money is going into your business than it is going out. Yay! This is good news.
Negative cash flow
When you see a negative cash flow, that means more money is going out of your business than it is going in. This is generally not great news.
The importance of net cash flow goes beyond making sure you stay in the positive and have enough money to keep the business running. It’s important to keep track of it over time to understand when and why cash flow fluctuations happen. In turn, this will allow you to identify issues early on before they develop into bigger issues, and plan ahead if you know a cash flow change is coming.
If you need to raise capital via business loan or investors, net cash flow is one of the relevant metrics. Lenders and potential investors will look at net cash flow to determine whether they can expect repayment of the loan or return on their investment.
What are the limitations of net cash flow?
When using the net cash flow formula, context is important.
For example, you might think a negative net cash flow points to danger for your business. While you want to aim for positive cash flow, a period or two of negative cash flow isn’t necessarily a bad thing. You may have purchased significant investments, like a brick-and-mortar shop, which can put a dent in your short-term cash flow. But over time, your business should be able to recover and get back to a positive cash flow.
On the other hand, you might assume your business is doing well if you have a positive cash flow… but what if you just received a huge loan and aren’t actually making sales? Your current net cash flow won’t show the full health of your business if you don’t add the relevant context.
This is also why it’s important to consider other metrics in addition to the net cash flow formula, like the free cash flow formula and the operating cash flow formula (psst, we have a handy article that covers this!)
Is net cash flow the same as net income?
Net cash flow and net income are similar, but there are key differences. While the net cash flow formula tells you how much operating cash moves in and out for a given period of time, net income also includes all expenses. Net income subtracts both operating expenses and non-operating expenses, such as taxes, depreciation, amortization, and others.
A net profit is when a company earns money after accounting for all those expenses, so the number is positive. When the number is negative, this is recorded as a net loss, and indicates the company has lost money for that period.
Net income gives a bigger, more accurate look into profitability, but net cash flow indicates a business’s ability to earn a profit from typical business operations. Both are important for helping you understand your business.
Moving forward with net cash flow
Once you understand how to use the net cash flow formula, you’ll have a better grasp on your business’s ability to generate liquid cash assets in a given period of time. Tracking your net cash flow over time will allow you to ensure your company can be profitable in both the short and long term. Three cheers for profitability!
Still hungry for more cash flow information? We cover three other important cash flow formulas in this handy article.
