Cash flow is the lifeblood of any business. Whether you’re just starting in the business world or have been in the game for a while, understanding cash flow is essential to success.
In this guide, we’ll give a concise overview of everything you need to know about net cash flow, from the basics of calculating this financial metric to how to use it to make better business decisions.
Additionally, we’ll make sure to answer some of the most common questions regarding net cash flow, including the key differences between net cash and net cash flow, its connection to other types of cash flows, and more.
So if you’re ready to get started, let’s jump right in and explore the world of net cash flow.
What is net cash flow?
Net cash flow is a key measure of the financial health of any business. It refers to actual cash balances over a given period after debts have been paid. It takes into account cash flow from various activities a company undertakes, including:
- Cash flow from operating activities
- Cash flow from investing activities
- Cash flow from financing activities
This makes net cash flow an essential metric for measuring business success. Net cash flow can help determine liquidity of a business and its financial ability to pay off long-term debt or finance investments in assets.
A net cash flow that’s positive indicates that the business has enough funds to pay its short-term obligations and is generating sufficient profits to grow and expand. In contrast, a negative net cash flow position signals that the company may be in financial distress and unable to meet its immediate obligations.
Business owners should regularly assess their net cash flow to ensure they make adequate profits and have sufficient funds available to meet any short-term liabilities. They should also review their net cash flow regularly to identify potential issues related to liquidity or solvency. Additionally, one might want to consider the impact of any changes in the economic climate on a company’s net cash flow. With careful monitoring and analysis of net cash flow, businesses can take proactive steps to ensure their financial stability in the future.
In accounting, net cash flow is typically reported in a statement of cash flows, which provides an overview of a company’s cash inflows and outflows during a period. The statement of cash flows is one of the key financial statements that are used by investors, creditors, and other stakeholders to evaluate a company’s financial health and performance.
What kinds of cash flows exist and does net cash flow fall into a standard cash flow category?
As mentioned above, there are three types of cash flows in accounting, including:
- Operating Cash Flows. Operating cash refers to the cash flow generated or used by a company’s day-to-day business operations and activities. Operating cash flows include cash received from customers, cash paid to suppliers and employees, and other operating expenses such as rent and utilities.
- Investing Cash Flows. This refers to the cash flow generated or used by a company’s investments in assets such as property, plant, and equipment or other long-term assets. Investing cash flows include cash used for the purchase of new assets and cash received from the sale of existing assets.
- Financing Cash Flows. This refers to the cash flow generated or used by a company’s financing activities, such as the issuance or repurchase of debt or equity securities. Financing cash flows include cash received from the issuance of new debt or equity, and cash used for the payment of dividends or the repurchase of shares.
These three types of cash flows — operating cash, investing cash, and financing cash flows — are important to analyze when evaluating a company’s financial health, as they’re accounting for how the company is generating and using its cash. By understanding a company’s cash flows, an investor or an analyst can easily assess its ability to meet its financial obligations, invest in growth opportunities, and generate returns for shareholders.
However, net cash flow is not a category of cash flows itself, but rather a summary measure of a company’s overall cash flow performance. It represents the difference between a company’s total cash inflows and total cash outflows over a specific period.
Net cash flow can actually be derived from these three categories of cash flows – operating, investing, and financing – that a company generates or uses during a period. Net cash flow is the sum of the cash flows from these activities.
Additionally, this type of cash flow is not to be confused with free cash flow. Free cash flow is the cash flow that a company generates after accounting for capital expenditures that are necessary to maintain its operations. It represents the cash that is available to a company for distribution to its investors or for use in growth opportunities.
In other words, while net cash flow measures the total cash inflows and outflows over a period, free cash flow measures the cash that is available for distribution or investment after accounting for necessary investments in long-term assets.
Therefore, net cash flow is a broader measure of a company’s cash flow performance. Yet, both measures are important for assessing a company’s financial health and performance, and investors often consider both when deciding on investing.
If you want to learn more about different types of cash flow, read our blog about the differences between direct and indirect cash flow.
What is the difference between cash flow and net cash flow?
Cash flow refers to the inflow and outflow of cash in a business or financial statement over a specific period. It includes all the cash that comes in and goes out, including revenues, various transactions, expenses, capital expenditures, and investments.
On the other hand, as mentioned before, net cash flow is the difference between the total cash inflow and the total cash outflow stemming from a company’s business activities over a specific period. It’s calculated by subtracting the cash outflow from the cash inflow.
In other words, net cash flow is the surplus or deficit of cash that a company has at the end of a specific period. If the inflow of cash is greater than the outflow, then the net cash flow is positive, indicating that the company has a surplus of cash. If the outflow of cash is greater than the inflow, then the net cash flow is negative, indicating that the company has a deficit of cash.
Therefore, while cash flow considers all the inflows and outflows of cash during a period, net cash flow focuses on the resulting cash balance after all cash inflows and outflows have been accounted for.
What is an example of net cash flow?
The best way to get a proper idea of what net cash flow actually is always a practical example.
Let’s say that a company had a total cash inflow of $50,000 during a specific period from sales revenue, and a total cash outflow of $40,000 for expenses, investments, various payments, capital expenditures, and similar activities.
To calculate the net cash flow, you would subtract the total cash outflow from the total cash inflow:
Net Cash Flow = Total Cash Inflow – Total Cash Outflow
Net Cash Flow = $50,000 – $40,000
Net Cash Flow = $10,000
In this example, the net cash flow is $10,000, which means that the company had a surplus of cash at the end of the period. This surplus of cash could be used for other investments or to pay dividends to shareholders.
Are net cash and net cash flow the same thing?
In short, no, net cash and net cash flow are not the same thing, although they are related.
Net cash refers to the total cash and cash equivalents that a company has on hand after deducting its current liabilities from its current assets. In other words, net cash represents the liquid funds that a company has available to use for investments, paying off debts, distributing to shareholders, or other financial activities.
Net cash flow, on the other hand, refers to the difference between the total cash inflows and outflows of a company over a specific period.
To put it simply, while net cash represents the total amount of cash a company has, net cash flow represents the change in that cash position over a specific period.
Why should a business keep track of its net cash flow?
Keeping track of your business’s net cash flow is an absolute necessity to ensure that your organization is successful and secure. Here are some benefits of regularly monitoring your net cash flow.
- Observe patterns. Looking at your net cash flow over a long period can give you a sense of how much money you’re generating and spending regularly. It can help you plan a budget and make changes to keep your business thriving and secure its financial health.
- Gauge development. Net cash flow can be the leverage to anticipate future success. If you’re making more money than you are spending, it’s a sign that your business is flourishing and likely to grow over time.
- Attract capital. Net cash flow can help potential investors decide if they want to put money into your business (e.g., by purchasing your stocks). These investors need to know if your business has enough funds to cover its costs. If not, they may want to reconsider. Additionally, if your company has shareholders, it should monitor its net cash flow closely to make sure it’s in a good financial state.
- Pinpointing areas for improvement. Examining your net cash flow can help you detect possible issues quickly, so you can take the appropriate measures before it’s too late. Being aware of and monitoring your net cash flow puts your business on the right track for long-term financial prosperity. As a result, your company will stay on top of the business game at all times.
Understanding net cash flow components
There are three distinct activities that contribute to a company’s total net cash flow: investing, financing and operating activities.
Investing activities involve buying or selling assets, such as property or equipment, that generate a positive cash flow for the company.
Financing activities relate to the issuance of debt or equity by the company, which also creates cash inflows.
Finally, operating activities refer to the day-to-day operations of the business, such as sales and expenses.
Investing, financing and operating activities ultimately determine how much net cash flow a company can generate for a given period.
How to calculate net cash flow — the cash flow formula
When you know what components and activities create a company’s net cash flow, it’s fairly simple to calculate it, as the net cash flow formula is pretty straightforward:
Net Cash Flow = Net Cash Flow from Operating Activities + Net Cash Flow from Financing Activities + Net Cash Flow from Investing Activities
First, find the cash flow from operating activities by subtracting the total operating expenses from the total revenue. Then, find the cash flow from financing activities by subtracting all financing costs from the total financing received. Finally, find the cash flow from investing activities by subtracting the total amount of investments made from the total amount of investments received. The sum of these three activities is your net cash flow.
Normally, you’ll have all the necessary numbers to calculate net cash flow by using the formula. Your company’s cash flow statement should reflect all the components, i.e., activities, so you shouldn’t encounter any hardships retrieving the data.
However, although they’re important, you might not track financing, investing and operating activities equally as a business owner, so you might want to seek help from your accountant to read the cash flow statement. They should be able to walk you through calculating net cash flow through this formula and keep track of all the vital activities.
What to do when net cash flow is negative?
Negative net cash flow might not necessarily mean you’re losing money and urgently requiring additional funding to survive as a business. As you track net cash flow for a given period, your cash flow statement might not reflect the cash you anticipate in the upcoming period because it doesn’t account for non-cash items. So, to see the true picture of your financial health, you usually need to combine the cash flow statement with the income statement.
Still, it might signalize you need some improvement in managing your cash flow. At this point, you might want to consider several steps, including:
Reviewing your billing and invoicing practices
This step includes two potential tactics, both pretty actionable. The first is to shorten the terms of receiving money from customers: from offering incentives for earlier payments (e.g., free shipping, discounts, etc.) to providing more convenient ways of making payments to automating your invoicing so as not to miss any overdue payments, etc. The second tactic is, obviously, extending your own due payment terms. You can try renegotiating them with suppliers to find the sweet spot that might satisfy both of you.
Rethinking your inventory practices
You may have products that aren’t moving through your business as fast as other products, sitting on shelves too long and eating up your cash. You might want to analyze your product performance to identify such products and either try to sell them at a discounted price or, in the worst-case scenario, write them off to free the storage space for more profitable products. You might as well rethink your supply to order less unpopular items or do it less frequently.
Reviewing your pricing
Raising prices might be a good source of increasing the cash coming into your business when you wisely approach it. To avoid the risks of losing customers, you might want to benchmark your prices against others in your niche. After all, being too low compared to the market can look suspicious and turn customers away just as being too expensive (and sometimes, even faster).
This is not all that you can do, of course. The general idea is to analyze your cash flow regularly to identify the possible leaks and opportunities to improve and react accordingly.
Net cash flow: The bottom line
Understanding net cash flow components is an essential part of financial management. It plays a critical role in determining the financial health of a business.
Generally, having a net cash flow that’s positive indicates that the business has sufficient funds to meet its obligations. On the other hand, a negative net cash flow can put the company in a precarious position and may require the business to seek additional financing.
To better understand net cash flow, it’s important to analyze the sources and uses of cash over time. By doing so, businesses can plan and make better decisions regarding their financial resources, thus improving their overall net cash flow.