The Cash Flow Formula: Definition, Types and Importance of Business 2023
aroundknowledge.co.id – There is a key formula a small business owner needs to know to track cash inflows and outflows. This cash flow formula will help you have enough cash to not only survive, but to grow and thrive.
Lenders and investors also look to this metric to assess the health of a business. This article provides an overview of the essential formulas every small business owner should know to manage cash flow effectively. But first, let's look at the definition of the cash flow formula.
What is the Cash Flow Formula?
The cash flow formula is a key component of financial analysis used by accountants and business owners. Calculate the net profit of your business with cash flow reports which provide valuable insights into various financial transactions.
Cash flow statements can range from focusing only on core business activities, such as manufacturing and sales, to include additional income, such as investment dividends. Analysts and investors scrutinize these statements to evaluate a company's overall financial position.
4 Important Cash Flow Categories
Cash flow analysis helps company owners see how much money is flowing in and out of the organization. There are many ways to analyze cash flows, some are preferred by operating managers and others are more important to outside investors.
A company's accounting objectives can determine which category of cash flows to use. The main cash flow categories are:
- Net Cash Flow: Net cash flow is a financial metric that reflects the amount of cash a company generates or loses in a given accounting period. This can be calculated by subtracting the total revenue from the total monetary cost.
- Operating Cash Flow: Operating cash flow analyzes whether a company generates net profit from operating its core business, such as sales or manufacturing. We focus on the financial inflows and outflows related to our core operations, excluding external investments or non-core operations.
- Free Cash Flow: Free cash flow denotes the total amount available for a company to use after paying off its debt obligations and paying dividends. Free cash can be used to invest in new businesses, distributed to shareholders, or used for day-to-day operations.
- Discounted Cash Flow: Discounted cash flow is used to determine the net present value (NPV) of an investment. NPV is the projected future value of a business minus its current asking price.
How to Calculate Cash Flow
The cash flow formula can be simple or complex. Many businesses today use accounting software to calculate cash flow, but it's important to understand the calculations. Following are the four main formulas used to calculate cash flow.
Net Cash Flow Formula
Net cash flow brings together the cash flows of the various components of the business. All formulas that track net cash flow provide the net cash balance for the accounting period by subtracting a company's expenses from available cash. The formula that can be used to calculate the company's cash flow is:
Net Cash Flow = Opening Cash Balance + (Operating Cash Inflow – Operating Cash Outflow) + (Cash Flow Investments – Cash Flow Investments) + (Cash Flow In Funding – Cash Flows Out treasury)
Cash Operations, Cash Investing, Cash Funding, Opening Balance – these factors can be positive or negative. For example, a construction company might have positive cash flow from financing activities, such as securing loans for new equipment or projects, but negative cash flow from operations because of higher material and labor costs tall.
As the business matures, you may see positive cash flow from operations when projects are completed and payments are received, but negative cash flow from financing activities because the loan is repaid in full active.
Operating Cash Flow Formula
To determine operating cash flow, you need to add up operating income from operating and non-cash expenses, then subtract operating expense outflows and changes in working capital. The formula is:
Operating Cash Flow = Operating Income + Non-Cash Expenses – Operating Expenses + Changes in Working Capital
Operating profit is the amount after deducting taxes and interest. Non-cash expenses include items such as issued shares and depreciation of fixed assets.
From this we deduct operational costs such as vendor fees, taxes and interest payments, together with changes in working capital, which represent the difference between current assets and liabilities.
Free Cash Flow Formula
Knowing a company's free cash flow is critical to understanding its operating costs. To calculate this, simply subtract the company's capital expenditures (expenses related to real estate and equipment, debt payments) from net operating profit after tax (net income, depreciation, amortization, and equity Work). The formula is:
Free Cash Flow = Net Operating Profit After Tax – Capital Charges
These calculations help measure the amount of money available for day-to-day operations and provide valuable insights for strategic decision making.
Discounted Cash Flow Formula
The discounted cash flow formula, unlike the operating or free cash flow formula, is more complex because includes projected inflows and outflows to determine the net present value of an item asset. Below is a brief explanation of the discounted cash flow formula.
Formula: Discounted Cash Flow = (CF1)1/(1+r) + (CF2)2/(1+r) … + (CFn) n/(1+r)
enter:
- CF1: First year cash flow
- CF2: Cash flow in year 2
- n: future period measured in years
- CFn: cash flow for the coming year
- r: discount rate or internal rate of return (IRR)
Note: The oval (…) in the formula indicates that a new input is added annually until the desired number of years in the future (denoted by n) is reached.
Investors use discounted cash flows to evaluate a company's investment potential. They forecast net income and cash balances for the next few years to assess whether the risk is worth taking.
Lenders also use it to evaluate the security of providing business loans. If you expect years of negative cash flow, you may choose not to lend to the company.
The discounted cash flow formula is a powerful tool for financial analysis and decision making in investment and lending scenarios.
Using the Cash Flow Formula for Business
Keeping an eye on cash flow is very important for small business owners. Figuring out these numbers may not sound exciting, but it's important to avoid any unwanted surprises.
Understanding the cash flow formula gives you a holistic view of your financial health. Help you proactively identify and solve cash flow problems.
By optimizing operations and strategically managing cash flow, you can overcome financial challenges and pave the way to long-term success.
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