What is Net Cash Flow: A Simple Guide for Business Owners

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 quickly cover everything you need to know about net cash flow, from the basics of calculating it to how to use it to make better business decisions. 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 operating activities, cash flow from investing activities, and cash flow from financing activities, making it an essential tool for measuring business success. Net cash flow can help measure a business’s liquidity and its ability to pay off long-term debt or finance investments in assets.

A positive net cash flow 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.

Why is net cash flow so important to track?

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 are generating and spending regularly. It can help you plan a budget and make changes to keep your business viable.

Gauge development. Net cash flow can be the leverage to anticipate future success. If you are making more money than you are spending, it is 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. 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 is 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 prosperity.

Understanding net cash flow components

There are three distinct activities that contribute to a company’s total net cash flow: investing, financing and operating. 

Investing activities involve buying or selling assets, such as property or equipment, that generate positive cash flows 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. 

These activities ultimately determine how much net cash flow a company can generate on a given period.

How to calculate net cash flow

Knowing what creates a company’s net cash flow, it’s fairly simple to calculate it. The formula for calculating net cash flow is pretty straightforward.. 

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 figures is your net cash flow. 

Net Cash Flow = Net Cash Flow from Operating Activities + Net Cash Flow from Financing Activities + Net Cash Flow from Investing Activities

Normally, you have all the necessary numbers to calculate net cash flow. Your company’s cash flow statement should reflect all the components, so you shouldn’t encounter any hardships retrieving the data. However, although they’re important, you might not track operating, financing, and investing 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.

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:

Review your billing and invoicing practices

Here, you basically have two tactics, both pretty actionable. The first is to shorten the terms of receiving money from customers: from offering incentives for earlier payments to providing more convenient ways of 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.

Rethink 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.

Review 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).

It is not all that you can do. The general idea is to analyze your cash flow regularly to identify the possible leaks and opportunities to improve and react accordingly.

Conclusion

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, a positive net cash flow 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 is 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.